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INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

OTHER TOPICS

Advertising Basics

William H. Brewster, Michael W. Rafter, Tywanda Harris Lord, Lisa Pearson, and Sabina A. Vayner

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Advertising BasicsWilliam H. Brewster, Michael W. Rafter, Tywanda Harris Lord, Lisa Pearson, and Sabina A. Vayner

I. Laws, Regulations, and Other Authorities Governing Advertising

At the federal level, two primary sources of law govern advertising claims: the Lanham Act and the Federal Trade Commission Act (“FTCA”). The Lanham Act, particularly § 43(a), proscribes false or misleading statements and gives competitors standing to sue.1 The FTCA grants the Federal Trade Commission (“FTC”) authority to regulate advertisements with the goal of protecting consumers.2

Most states have passed Unfair and Deceptive Trade Practices Acts, with some adopting the Uniform Unfair and Deceptive Trade Practices Act to govern state-law claims.3 Several states have also passed false advertising statutes as a supplement or alternative to the Uniform Act.4

Advertising claims may also be subject to industry-specific laws and regulations. For example, the Textile and Wool Acts provide a number of rules for the advertisement of clothing,5 and advertising practices associated with food and drug advertisements are heavily regulated as well.6 Television networks have also promulgated Network Advertising Guidelines that articulate important factors in determining which advertisements are proper for television viewing.7

II. General Principles and Frequent Topics in Advertising Law

Courts have interpreted the elements of a false advertising claim under the Lanham Act, § 43(a), as: “(1) a false statement of fact by the defendant in a commercial advertisement about its own or another’s product; (2) the statement actually deceived or has the tendency to deceive a substantial

1 “Any person who, on or in connection with any goods or services . . . uses in commerce any word, term, name, symbol or device, or any combination thereof, or any . . . false or misleading description of fact, or false or misleading representation of fact, which . . . (B) in commercial advertising or promotion, misrepresents the nature, characteristics, qualities, or geographic origin of his or her or another person’s goods, services or commercial activities, shall be liable in a civil action by any person who believes that he or she is likely to damaged by such act.” Trademark Act of 1946, 15 U.S.C. § 1125(a)(1) (2006) (“Lanham Act”).

2 Section 5 of the FTCA declares that “[u]nfair or deceptive acts or practices in or affecting commerce are hereby declared unlawful.” 15 U.S.C.A. § 45(a)(1) (2006). This section, in combination with § 12(a) —which discusses the dissemination of false advertisements and states that “[i]t shall be unlawful for any person, partnership, or corporation to disseminate, or cause to be disseminated, any false advertisement . . . (2) By any means, for the purpose of inducing, or which is likely to induce, directly or indirectly, the purchase in or having an effect upon commerce, of food, drugs, devices, services, or cosmetics” —establishes the authority for false advertising enforcement in the FTC. Id. § 52(a). Section 13(b) then authorizes the FTC to seek preliminary and permanent injunctions for violations of the FTCA. Id. § 53(b). The full text of the FTCA is available online at http://www.fda.gov/opacom/laws/ftca.htm.

3 See, e.g., Colo. Rev. Stat. ann. §§ 6-1-101 to 6-1-115 (West 2002 & Supp. 2008) (1966 revision); Ga. Code ann. §§ 10-1-370 to 10-1-375 (2000 & Supp. 2008); Minn. Stat. §§ 325D.43–.48 (1966 revision); ohio Rev. Code ann. §§ 41.4165.01-4165.04 (West 2007 & Supp. 2008) (1966 revision); okla. Stat. ann. tit. 78, §§ 51–55 (West 2002 & Supp. 2008); oR. Rev. Stat. ann. §§ 646.605–.656 (West 2003 & Supp. 2008) (1966 revision); see also http://law.findlaw.com/state-laws/deceptive-trade-practices.

4 See, e.g., Cal. BuS. & PRof. Code ann. § 17500 et seq. (West 2008); Ga. Code ann. §§ 10-1-420, -421 (2000 & Supp. 2008); n.Y. Gen. BuS. § 350 (McKinney 2004 & Supp. 2008). See also http://law.findlaw.com/state-laws/deceptive-trade-practices.

5 See Facts for Business: Threading Your Way Through the Labeling Requirements Under the Textile and Wool Acts, available at http://www.ftc.gov/bcp/edu/pubs/business/textile/bus21.shtm.

6 See, e.g., Bruce I. McDaniel, What Constitutes “False Advertising” of Drugs or Devices Within § 5 and 12 of the Federal Trade Commission Act (15 U.S.C.A. § 45, 52), 49 a.l.R. fed. 16 (1980); Bruce I. McDaniel, What Constitutes “False Advertising” of Food Products or Cosmetics Within §§ 5 and 12 of the Federal Trade Commission Act (15 U.S.C.A. §§ 45, 52), 50 a.l.R. fed. 16 (1980).

7 See, e.g., ABC Television Network Advertising Standards and Guidelines (on file with the FTC), and reprinted in 1 do’S & don’tS of adveRtiSinG § 4 at 60 (Council of Better Business Bureaus Sept. 2002).

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segment of its audience; (3) the deception is material, in that it is likely to influence the purchasing decision; (4) the defendant caused its false statement to enter interstate commerce; and (5) the plaintiff has been or is likely to be injured as a result of the false statement, either by direct diversion of sales from itself to defendant or by a lessening of the goodwill associated with its products.”8

The FTC, which brings administrative actions under the provisions of the FTCA, issued its Policy Statement on Deception in 1983 to address the factors the FTC considers in evaluating false advertising claims.9 The FTC enumerated three primary factors: (1) “a representation, omission or practice that is likely to mislead the consumer;” (2) “the perspective of a consumer acting reasonably in the circumstances;” and (3) “the representation, omission, or practice must be a ‘material’ one.”10 In summary, “the Commission will find deception if there is a representation, omission or practice that is likely to mislead the consumer acting reasonably in the circumstances, to the consumer’s detriment.”11

A. “Puffery” is not Actionable

Statements perceived as exaggeration or boasting, sometimes called “puffery,” are generally permitted and are not actionable as false or misleading advertising. The distinction turns on whether the statement is one of fact, and thus objective, or one of general opinion, and thus subjective. A statement of fact is actionable, while a statement of general opinion is not.12

Courts have held that puffery can arise in at least two forms: “(1) an exaggerated, blustering, and boasting statement upon which no reasonable buyer would be justified in relying; or (2) a general claim of superiority over comparable products that is so vague that it can be understood as nothing more than a mere expression of opinion.”13 Nevertheless, if this vague, “general claim” of superiority becomes objectively concrete when viewed in the context of the overall advertisement, puffery may become actionable false advertising.14

The line between puffery and an actionable claim can be murky. For example, courts have found the following statements to be non-actionable puffery:

(1) “Best Beer in America,”15 (2) “the Most Advanced Home Gaming System in the Universe,”16

(3) “less is more,”17 and

8 Southland Sod Farms v. Stover Seed Co., 108 F.3d 1134, 1139 (9th Cir. 1997). See also U.S. Healthcare, Inc. v. Blue Cross of Greater Philadelphia, 898 F.2d 914, 922–23 (3d Cir. 1990).

9 FTC Policy Statement on Deception, appended to In re Cliffdale Assocs., Inc., 103 F.T.C. 110, 174 (1984), available at http://www.ftc.gov/bcp/policystmt/ad-decept.htm.

10 Id.11 Id.12 See, e.g., Pizza Hut, Inc. v. Papa John’s Int’l, Inc., 227 F.3d 489, 495–96 (5th Cir. 2000). 13 Id. at 497.14 See, e.g., id. at 496.15 In re Boston Beer Co., 198 F.3d 1370, 1372 (Fed. Cir. 1999).16 Atari Corp. v. 3DO Co., 31 U.S.P.Q.2d 1636, 1636 (N.D. Cal. 1994).17 Southland Sod Farms v. Stover Seed Co., 108 F.3d 1134, 1145 (9th Cir. 1997).

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(4) “anything closer would be too close for comfort.”18

On the other hand, courts have held these statements to be verifiable facts rather than puffery:

(1) “longer engine life and better engine protection,”19

(2) “50% Less Mowing,”20 and(3) “stops pain immediately.”21

A single advertisement may contain both types of advertising claims. In a case involving advertisements for laundry detergent, the statement “whiter is not possible” was held to be an implied direct comparison to chlorine bleach, while other statements, including “hit the white spot with just one shot,” were held to be vague, unspecified boasting typical of puffery.22

Pizza Hut v. Papa John’s provides a good example of how the context of an advertisement can transform a statement that otherwise might be puffery into an actionable statement of fact. In that case, Pizza Hut sued Papa John’s for use of the advertising slogan “Better Ingredients. Better Pizza.”23 In its analysis, the Fifth Circuit first considered the slogan standing alone and dissected the two sentences to determine whether each part was a statement of fact or opinion. Finding both parts of the statement to be non-actionable opinion, the court reasoned that “it is clear that the assertion by Papa John’s that it makes a ‘Better Pizza’ is a general statement of opinion regarding the superiority of its product over all others. This simple statement . . . epitomizes the exaggerated advertising, blustering, and boasting by a manufacturer upon which no consumer would reasonably rely.”24 The court continued that “it is difficult to think of any product, or any component of any product, to which the term ‘better,’ without more, is quantifiable,”25 and concluded that the four word slogan, taken as a whole, was non-actionable puffery.26

The Fifth Circuit then addressed the use of the slogan in a series of comparative advertisements that compared Papa John’s sauce and dough to that of its competitors in the pizza delivery business, including Pizza Hut.27 Affirming the jury’s verdict, the court held that the commercials were misleading statements of fact actionable under the Lanham Act.28 When evaluated within the comparative advertisements, the court agreed that the message communicated by the slogan “is expanded and given additional meaning” such that it is no longer an opinion but instead an

18 Gillette Co. v. Norelco Consumer Prods. Co., 946 F. Supp. 115, 130 (D. Mass. 1996).19 Castrol Inc. v. Pennzoil Co., 987 F.2d 939, 941, 946 (3d Cir. 1993).20 Southland Sod Farms, 108 F.3d at 1145 (stating that “50% Less Mowing” is “a specific and measurable advertisement claim of product

superiority based on product testing and, as such, is not puffery”).21 Am. Home Prods. Corp. v. Abbott Labs., 522 F. Supp. 1035 (S.D.N.Y. 1981).22 Clorox Co. Puerto Rico v. Procter & Gamble Commercial Co., 228 F.3d 24, 28, 39 (1st Cir. 2000).23 Pizza Hut, 227 F.3d at 491.24 Id. at 498. See also Am. Italian Pasta Co. v. New World Pasta Co., 371 F.3d 387 (8th Cir. 2004) (holding “America’s favorite pasta”

statement to be puffery).25 Id. at 499.26 Id.27 Id. at 500–03.28 Id. at 502.

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actionable statement of fact, reasoning that the context of the commercials had transformed the general word “better” into a modifier for specific items that could be measured objectively.29 In the end, the court found that the misleading statements were not material to the consumer purchasing decision and, as a result, Papa John’s prevailed in the suit.30 The case nevertheless offers a good example of the contextual factors that can transform even the most evident puffery into an actionable statement of fact.

B. Both Express and Implied Claims can be False or Misleading

Advertising claims are actionable under the Lanham Act regardless of whether the claim is expressly stated or simply implied. The fundamental difference between the two types of statements is that “[e]xpress claims directly represent the fact at issue while implied claims do so in an oblique or indirect way.”31

Implied claims can arise in a variety of situations. A combination of elements such as slogans, descriptions, and photographs may result in a misleading impression, even though each standing alone is non-actionable.32 Likewise, an entire package, taken as a whole, may be implicitly misleading, even though the labels themselves are not.33 An advertisement stating that each slice of cheese is made with five ounces of milk, while truthful, still falsely implied to reasonable consumers that each slice contained as much calcium as five ounces of milk and was therefore held to be misleading in Kraft, Inc. v. FTC.34 In yet another case, a statement that a product offered “the strong relief of aspirin” was interpreted by the court to contain an implied claim that the product actually contained aspirin, when it did not.35

C. Substantiation: All Verifiable (Objective) Statements Must Be Supported

The concept of substantiation arose in the FTC in the mid-1980s, with the D.C. Circuit’s holding in Thompson Medical Co., Inc. v. FTC.36 Unlike prior jurisprudence, this case and the ensuing FTC Policy Statement Regarding Advertising Substantiation established that advertisers could no longer make statements without a “reasonable basis” for their claims, and that all claim substantiation must occur prior to the advertisement and cannot later be established through post-advertisement testing.37 More than twenty years later, the rule is the widely-accepted standard in federal court.

29 Id. at 501–02.30 Id. at 504.31 Kraft, Inc. v. FTC, 970 F.2d 311, 319 n.4 (7th Cir. 1992).32 Stanley Labs. v. FTC, 138 F.2d 388 (9th Cir. 1943) (use of “M.D.” in conjunction with the phrase “dependable safeguard” may lead to the

conclusion that the product has contraceptive uses).33 Kenny v. Gillet, 17 A. 499 (Md. 1889).34 970 F.2d 311.35 In re Thompson Med. Co., 104 F.T.C. 648, aff’d, 791 F.2d 189 (D.C. Cir. 1986).36 791 F.2d 189 (D.C. Cir. 1986). 37 FTC Policy Statement Regarding Advertising Substantiation, appended to Thompson Med. Co., 104 F.T.C. 648, 839 (1984), aff’d, 791

F.2d 189 (D.C. Cir. 1986), available at http://www.ftc.gov/bcp/guides/ad3subst.htm.

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The FTC’s 1984 Policy Statement Regarding Advertising Substantiation set forth the substantiation requirement for advertising.38 At the first level, puffery requires no substantiation at all, since it is non-actionable.39

The next level requires the advertiser to have a “reasonable basis” for any product claim that makes “objective assertions about the item or service advertised,” but does not provide “an express or implied reference to a certain level of support.”40 In making this “reasonable basis” determination, the FTC evaluates six factors: “(1) the product involved; (2) the type of claim made; (3) the benefits of a truthful claim; (4) the ease of developing substantiation; (5) the consequences to the consumer of a false claim; and (6) the amount of substantiation which experts in the field consider reasonable.”41 For challengers of the advertisement, evidence showing the assertion’s falsity is required.

The highest level of proof is necessary when an advertisement, either explicitly or implicitly, claims to be supported by testing or scientific research, or indicates any specific level of support.42 These claims, sometimes called “establishment claims,” require the advertiser to show the same level of substantiation as presented in the advertisement. With establishment claims, false advertising can be shown by demonstrating that the tests on which the statement relies are “not sufficiently reliable to permit one to conclude with reasonable certainty that they established the proposition for which they were cited.”43 Thus the standard of proof for a challenger is lowest for establishment claims, as the challenger must show only that the tests fail to support the advertiser’s claim to prevail, rather than proving that the product lacks the claimed characteristic.

D. Literally False Statements as well as Literally True but Misleading Statements are Actionable

Courts recognize two primary types of claims in false advertising: (1) those statements that are literally false on their face; and (2) those statements that, while literally true, still have a tendency to mislead or deceive relevant consumers.44 Some courts recognize a sub-category of literally false claims—those that are literally false “by necessary implication.”45

In distinguishing the two types of claims, courts state that “[a] literally false statement can be determined as a matter of law, but whether a statement is misleading is considered a matter of fact.”46 This delineation has the practical consequence that, “[w]hen a merchandising statement

38 Id.39 Id.40 Id.41 1A louiS altMan & Malla PollaCk, CallMann on unfaiR CoMPetition, tRadeMaRkS and MonoPolieS § 5:21 (4th ed. 2008).42 FTC Policy Statement Regarding Advertising Substantiation, supra note 37.43 Castrol, 987 F.2d at 958 n.13 (quoting Procter & Gamble Co. v. Chesebrough-Pond’s Inc., 747 F.2d 114, 119 (2d Cir. 1984)). See also

United Indus. Corp. v. Clorox Co., 140 F.3d 1175, 1182 (8th Cir. 1998).44 Johnson & Johnson v. GAC Int’l, Inc., 862 F.2d 975, 977 (2d Cir. 1988).45 This category of claims has been considered by the First, Second, Third, Fourth, Ninth, and Tenth Circuits. See, e.g., Clorox Co. Puerto

Rico v. Procter & Gamble Commercial Co., 228 F.3d 24 (1st Cir. 2000); Time Warner Cable, Inc. v. DirecTV, Inc., 497 F.3d 144 (2d Cir. 2007); Novartis Consumer Health, Inc. v. Johnson & Johnson-Merck Consumer Pharms. Co., 290 F.3d 578 (3d Cir. 2002); Scotts Co. v. United Indus. Corp., 315 F.3d 264 (4th Cir. 2002); Southland Sod Farms v. Stover Seed Co., 108 F.3d 1134, 1139 (9th Cir. 1997); Zoller Labs., LLC v. NBTY, Inc., 111 F. App’x 978 (10th Cir. 2004).

46 Allsup, Inc. v. Advantage 2000 Consultants Inc., 428 F.3d 1135, 1138 (8th Cir. 2005).

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or representation is literally or explicitly false, the court may grant relief without reference to the advertisement’s impact on the buying public . . . [but when] the challenged advertisement is implicitly rather than explicitly false, its tendency to violate the Lanham Act by misleading, confusing or deceiving should be tested by public reaction.”47 In other words, a competitor challenging an advertising claim that is literally true, but allegedly misleading, will need to present evidence that the claim does in fact mislead consumers. The challenger usually gathers evidence by conducting surveys in which consumer perceptions of the advertisement are tested.

1. Literally False Claims: Courts Presume that Consumers are Deceived

Statements that are literally false do not require a challenger to show evidence of consumer confusion or deception. If an advertisement is false on its face, a competitor harmed by it can obtain an injunction without having to show extrinsic evidence that consumers were actually misled by the advertisement. Furthermore, if the challenger is seeking a preliminary injunction, the court may presume that irreparable injury will result should the injunction be denied.48 Basically, if a claim is literally false, courts will presume actual deception.49

As a preliminary matter, however, one must first determine that a statement is, in fact, false on its face. “In analyzing whether an advertisement . . . is literally false, a court must determine, first, the unambiguous claims made by the advertisement . . . , and second, whether those claims are false.”50 The Third Circuit undertook this analysis in Novartis Consumer Health, Inc. v. Johnson & Johnson-Merck Consumer Pharmaceuticals Co., and concluded that “only an unambiguous message can be literally false.”51

In Cashmere & Camel Hair Manufacturers Institute v. Saks Fifth Avenue, for example, the First Circuit found that a presumption of consumer deception attached to literally false label statements, such as those wherein blazers containing less than 1% of cashmere were advertised as “10% cashmere” and where labeling the blazers as “cashmere” rather than “recycled cashmere” was literal falsity.52

a) Claims that are Literally False by Necessary Implication

Some courts recognize claims that involve a statement that, while not literally false on its face, is nevertheless literally false given the circumstances.53 Such claims arise “when, considering the advertisement in its entirety, the audience would recognize the claim as readily as if it had been explicitly stated.”54 In determining whether a claim is false by necessary implication, courts inquire whether, based on a facial analysis of the product name or advertising, the consumer will unavoidably receive a false message from the product’s name or advertising.

47 Coca-Cola Co. v. Tropicana Prods., Inc., 690 F.2d 312, 317 (2d Cir. 1982), abrogated on other grounds by Fed. R. Civ. P. 52(a).48 altMan & PollaCk, supra note 41 § 5:23.49 See, e.g., U-Haul Int’l, Inc. v. Jartran, Inc., 793 F.2d 1034, 1040 (9th Cir. 1986).50 Novartis Consumer Health, Inc., 290 F.3d at 586.51 Id. at 587 (emphasis in original).52 284 F.3d 302 (1st Cir. 2002).53 See supra note 45.54 Clorox Co. Puerto Rico, 228 F.3d at 35.

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For example, in Cuisinarts, Inc. v. Robot-Coupe International Corp., a federal district court found literal falsity by necessary implication in an advertisement for professional food processors.55 The advertisement stated that all fine French restaurants chose Robot-Coupe’s professional processors over those of competitor Cuisinart, thus necessarily implying that Cuisinart not only produced a professional model food processor (which it did not) but also that that the restaurants in question had chosen the Robot-Coupe over the Cuisinart model (which they had not).56

Similarly, the Third Circuit in Novartis analyzed whether statements associated with the advertising of Mylanta Night Time Strength were literally false by necessary implication. Although the product advertised nighttime relief, the product formulation was that of an extra strength antacid, without any additional enhancements or sleep aids. Holding that the name of the product—Mylanta Night Time Strength—necessarily implied that it was specially formulated for nighttime relief of heartburn, the court upheld the lower court’s decision and further noted that “the greater the degree to which a message relies upon the viewer or consumer to integrate its components and draw the apparent conclusion . . . the less likely it is that a finding of literal falsity will be supported.”57

2. Literally True but Misleading Claims: Evidence of Actual Deception Required

Unlike literally false statements, the standard for literally true but misleading claims requires a challenger to show that the advertisement has in fact misled or deceived consumers.58 Challengers will often rely on consumer surveys to show either consumer deception or lack thereof.59 This additional burden of proof was explained by the court in American Council of Certified Podiatric Physicians and Surgeons: “[w]here statements are literally true, yet deceptive, or too ambiguous to support a finding of literal falsity, a violation can only be established by proof of actual deception . . . . A plaintiff relying upon statements that are literally true yet misleading cannot obtain relief by arguing how consumers could react; it must show how consumers actually do react.”60

An illustrative case is Sandoz Pharmaceuticals Corp. v. Richardson-Vicks, Inc.61 Finding that Sandoz had failed to establish that an advertisement for Vick’s Pediatric Formula 44 was misleading to consumers absent any consumer survey evidence, the Third Circuit explained that “where the advertisements are not literally false, plaintiff bears the burden of proving actual deception by a preponderance of the evidence.”62 The court reasoned that the “effect of the advertisement on the consumer is the critical determination, and it must be demonstrated by a Lanham Act plaintiff

55 No. 81CIV731-CSH, 1982 WL 121559 (S.D.N.Y. June 9, 1982). Although unreported, this case has been heavily cited in subsequent cases. See, e.g., Novartis Consumer Health, Inc., 290 F.3d 578; Southland Sod Farms, 108 F.3d at 1139; Castrol Inc. v. Pennzoil Co., 987 F.2d 939, 941, 946–47 (3d Cir. 1993).

56 Id.57 Novartis Consumer Health, Inc, 290 F.3d at 587 (quoting United Indus. Corp. v. Clorox Co., 140 F.3d 1175, 1181 (8th Cir. 1998)).58 Am. Home Prods. Corp. v. Johnson & Johnson, 577 F.2d 160, 165–66 (2d Cir. 1978); Sandoz Pharms. Corp. v. Richardson-Vicks, Inc.,

902 F.2d 222, 228–29 (3d Cir. 1990).59 See, e.g., Am. Home Prods., 577 F.2d at 166–68; Tropicana Prods., Inc., 690 F.2d 312.60 Am. Council of Certified Podiatric Physicians & Surgeons v. Am. Bd. of Podiatric Surgery, 185 F.3d 606, 614 (6th Cir. 1999) (internal

quotation marks omitted). See also Sandoz Pharms. Corp., 902 F.2d at 229.61 902 F.2d 222.62 Id. at 228–29 (internal citation omitted).

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regardless of whether the claim is facially ambiguous.”63 Thus, without evidence of actual consumer misinterpretation, the claim for literally true but misleading statements could not be upheld.

To prove a Lanham Act claim based upon misleading but literally true advertising statements, the plaintiff must present survey or other evidence showing that consumers are actually misled. The FTC, however, has no such requirement in proceedings brought before it under the FTC Act.64 The FTC, in its discretion, determines whether to admit extrinsic evidence to show implied falsity. If it chooses, the FTC can determine the implication of an advertisement without the admission of any extrinsic evidence whatsoever. In appeals from such determinations, courts typically defer to the FTC’s practice because “the FTC’s unique expertise and experience regarding consumer expectations allows it to determine for itself the level of substantiation consumers expect to support an advertising claim.”65 Such judicial deference is not without critics, however.66

Similarly, in alternative dispute resolution proceedings before the National Advertising Division (“NAD”),67 the NAD does not require challengers to submit evidence of actual consumer deception in connection with allegedly misleading advertising claims, although it will consider any such evidence submitted. In the absence of surveys or other consumer perception evidence, however, the NAD will rely on its own precedent to reach a conclusion.

E. Images can be False or Misleading

Images used in advertisements can communicate a false or misleading message, either explicitly or implicitly.

For example, the Second Circuit has held that a television advertisement visually representing orange juice made by squeezing oranges and pouring freshly-squeezed juice directly into the carton was false on its face when, in fact, the orange juice was actually pasteurized and prepared through a process of heating and sometimes freezing prior to packaging.68

On the other hand, an illustration of mature crabgrass directly above the phrase “prevents crabgrass up to 4 weeks after germination” was held by the Fourth Circuit to be neither literally false, nor literally false by necessary implication.69 Although the challenger argued that this image, in connection with the text, would mislead consumers into believing the product actually killed already-existing mature crabgrass, the court found that this inference was unlikely and unsupported. Likewise, the Second Circuit found an Internet image depicting a competitor’s extremely bad television reception to be so exaggerated and inaccurate that no reasonable consumer would believe it to be a realistic depiction and thus, in context, constituted mere puffery.70

63 Id. at 229. 64 Id.65 Id. See also Kraft, Inc. v. FTC, 970 F.2d 311 (7th Cir. 1992); FTC v. Colgate-Palmolive Co., 380 U.S. 374, 385 (1965); Am. Home Prods.

Corp. v. FTC, 695 F.2d 681, 687 n.10 (3d Cir. 1982); Thompson Med. Co. v. FTC, 791 F.2d 189, 197 (D.C. Cir. 1987).66 Kraft, Inc., 970 F.2d at 327–28 (concurring opinion).67 See infra Section III for further discussion of NAD proceedings.68 Tropicana Prods., Inc., 690 F.2d at 317–18.69 Scotts Co., 315 F.3d at 274–75.70 Time Warner v. DirecTV, 497 F.3d 144 (2d Cir. 2007) (Second Circuit reversed district court’s finding of literal falsity).

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Advertisers should thus be attuned to the messages communicated to consumers by the visual components of their advertising, and take care that these components are adequately substantiated.

F. Disclaimers and Disclosures Often are Insufficient to Cure a False or Misleading Message

Disclosures and disclaimers are often used by advertisers to correct potential misperceptions by consumers. Although such devices sometimes may be sufficient to cure otherwise deceptive advertising, they often fail to be effective. In particular, merely placing a small or inconspicuous disclaimer at the bottom or in the corner of an advertisement that would otherwise be misleading usually does nothing to fix the advertisement’s misleading message. Even when advertisers go so far as to prominently display the disclaimer or qualifying phrase on their advertisements, such language may not negate a message that may be deceptive as a whole.

Courts have sometimes approved disclaimers that explain a potentially misleading message.71 For example, in Potato Chip Institute v. General Mills, the Fourth Circuit noted that “it is well settled that if the contested phrase is susceptible to two meanings so that an explanatory phrase will preclude deception, it is sufficient to require the addition of the explanation rather than prohibit using the ambiguous phrase.”72 In that case, the court held that the term “potato chip” conveyed a specific impression in the minds of consumers such that they would be misled into thinking the product was made from raw potatoes. When used in conjunction with such phrases as “fashioned from dried potato granules,” however, this statement was sufficient to ensure that consumers would not be misled. The court did note, nonetheless, that advertisements for the product on television, in which only the term “potato chip” was used, would no longer be permitted.73

Claims such as “Rated No.1” and “Proved the Best” can also often mislead unless accompanied by a disclosure of the essential facts and the tests on which the claims are made. Such disclosures should include the identity of the organization making the tests upon which the claims are based, the type of tests that were conducted (i.e., lab, clinical), and in what specific respects the product is deemed to be superior. Furthermore, if the advertiser owns or controls the agency making the statement, this fact should be prominently displayed.

For example, the District of Columbia Circuit held that the term “manufacturer’s list price” in a retailer’s advertisement misled the public into believing that this price was the price at which the product was customarily sold by competitors in the area. The disclaimer, printed in small print at the bottom of the advertisement and purporting to explain the meaning of the term “manufacturer’s list price” was held insufficient to correct the deceptive use of the term.74

In evaluating the sufficiency of disclaimers, courts look to the overall impression created by the advertisement. In American Home Products, the court held that “[i]f the advertisement contains a definition or disclaimer which purports to change the apparent meaning of the claims and render

71 See, e.g., Potato Chip Inst. v. Gen. Mills, Inc., 333 F. Supp. 173 (D. Neb. 1971), aff’d, 461 F.2d 1088 (8th Cir. 1972). 72 461 F.2d at 1089.73 333 F. Supp. at 181.74 Giant Food Inc. v. FTC, 322 F.2d 977, 986 (D.C. Cir. 1963).

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them literally truthful, but which is so inconspicuously located or in such fine print that readers tend to overlook it, it will not remedy the misleading nature of the claims.”75 The court further noted that the meaning of an advertisement to the target audience—and hence, the effectiveness of a disclaimer—is best established through well-designed surveys.76

G. Comparative Advertising

A frequently used strategy in advertising is the comparison of a product to a competitor’s similar product. In the United States, comparative advertising is permissible, but only so long as the advertiser can adequately substantiate all claims, whether or not those claims directly reference particular competitors.77 Comparative advertising encompasses both superiority and parity claims, as well as claims that are implicit in their comparison to other products.

1. Superiority Claims

Superiority claims are those that make the assertion, whether explicitly or implicitly, that the product advertised is better than all others in the marketplace, or better than the product sold by a specific competitor. In making claims of superiority, statements that a product has the “most sales,” or is the “oldest” or “biggest” in the market are objective claims, requiring the advertiser to substantiate such claims by showing that his product truly is the “oldest,” “biggest,” or had the “most sales” last year. More generalized superiority claims, such as use of the word “best” in advertising, in contrast, are so broad as to be subjectively superior and thus considered non-actionable puffery.

The line between subjectively and objectively superior claims is not always clear. For example, in Johnson & Johnson-Merck Consumer Pharmaceuticals Co. v. Rhone-Poulenc Rorer Pharmaceuticals, Inc.,78 Rhone-Poulenc made the claim that its antacid was the “strongest antacid there is” in television commercials. Although the statement appeared capable of verification through objective testing, the Second Circuit held in favor of Rhone-Poulenc, stating that such a general statement was not actionable as false advertising absent consumer surveys showing that the advertisements misled the public into thinking Maalox was a superior product.79

2. Parity Claims

Parity claims are those which compare the advertiser’s product to others in the marketplace and assert that their product is “as good as” the competitor’s. Like superiority claims, parity claims must also be substantiated if they are objectively verifiable.

75 Am. Home Prods. Corp. v. Johnson & Johnson, 654 F. Supp. 568, 590 (S.D.N.Y. 1987).76 Id.77 In certain other countries, comparative advertising is prohibited or may give rise to trademark infringement or other claims by the

competitor whose product is compared. Before engaging in comparative advertising in a new country, it is prudent to consult counsel well-versed in the advertising and unfair competition laws of that country. See, e.g., European Commission: Consumer Affairs, Misleading and Comparative Advertising, http://ec.europa.eu/consumers/cons_int/safe_shop/mis_adv/index_en.htm (last visited Mar. 17, 2009).

78 19 F.3d 125 (3d Cir. 1994).79 Id. See also Chesebrough-Pond’s Inc., 747 F.2d 114.

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In Procter & Gamble Co. v. Chesebrough-Pond’s Inc., for example, both manufacturers sued each other for false advertising associated with hand and body lotions.80 While Procter & Gamble’s advertisements contained claims of superiority, Chesebrough claimed parity for its Vaseline Intensive Care Lotion, making statements such as, “[w]hen it comes to relieving dry skin, no leading lotion beats Vaseline Intensive Care Lotion.”81 Both parties provided clinical tests to substantiate their assertions and the district court held that neither party could show that the other’s tests were invalid or misleading. The Second Circuit upheld the district court’s decision, allowing both parties to continue their advertising, concurrently making both superiority (Procter & Gamble) and parity (Chesebrough) claims.82

H. Testimonials and Endorsements

Endorsements can be a valuable tool in advertising a product, particularly when made by a high-profile celebrity. Use of endorsements, however, must adhere to particular guidelines to avoid claims of false advertising.

To aid advertisers, the FTC issued Guides Concerning the Use of Endorsements and Testimonials in Advertising (the “Endorsement Guides”).83 The FTC treats testimonials and endorsements identically in the context of advertising, and describes both as:

any advertising message (including verbal statements, demonstrations, or depictions of the name, signature, likeness or other identifying personal characteristics of an individual or the name or seal of an organization) which message consumers are likely to believe reflects the opinions, beliefs, findings, or experience of a party other than the sponsoring advertiser. The party whose opinions, beliefs, findings, or experience the message appears to reflect will be called the endorser and may be an individual, group or institution.84

The FTC Endorsement Guides also provide examples of advertisements that do and do not constitute endorsements. A famous golfer hitting golf balls in an advertisement for those golf balls would constitute an endorsement, as would a quote from a movie critic used in the advertisement for a new movie.85 On the other hand, an advertisement depicting two women in a grocery store, in which one tells the other that she only uses a specific brand to clean all of her family’s clothing would not.86

If “the advertisement represents that the endorser uses the product, then the endorser must have been a bona fide user of it at the time the endorsement was given” so as not to constitute false advertising.87 Nor can the advertisement continue to be used if the advertiser no longer has a “good reason to believe” that the endorser is still a bona fide user of the product.88

80 747 F.2d 114.81 Id. at 116.82 Id. at 120.83 16 C.F.R. § 255.0 (2008), available at http://www.ftc.gov/bcp/guides/endorse.htm.84 Id. § 255.0(a)–(b).85 Id. § 255.0(d).86 Id. § 255.0(d).87 Id. § 255.1(c).88 Id. § 255.0(d).

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A leading case illustrating how an advertiser can run afoul of endorsement requirements is Waits v. Frito Lay.89 In that case, Frito Lay used a Tom Waits song sung by a sound-a-like artist without Waits’s permission in its advertisement for Doritos. Waits prevailed on a false endorsement theory under the Lanham Act, with the court holding that the unauthorized imitation of his distinctive voice may lead consumers to believe that Waits actually approved of the product and sponsored it.90

In December 2008 and January 2009, the FTC accepted comments on its proposed revisions to the Endorsement Guides, particularly regarding “consumer endorsements, expert endorsements, endorsement by organizations, and disclosure of material connections between advertisers and endorsers.”91 The FTC noted that “[o]n the issue of consumer endorsements, the proposed revisions state that testimonials that do not describe typical consumer experiences should be accompanied by clear and conspicuous disclosure of the results consumers can generally expect to achieve from the advertised product or program.”92 These suggested revisions would affect, for example, advertisements in which a spokesperson states that he has lost fifty pounds using the advertised product, but the typical consumer loses significantly less weight when using the product.

I. Specific Language Used in Advertising

1. “Recyclable,” “Biodegradable,” “Compostable,” and Other Environmental Advertising Claims

The FTC’s Guides for the Use of Environmental Marketing Claims, often referred to as the “Green Guides,” set out guidelines for use of specific terminology in advertising, but do not purport to define the terms scientifically or offer proper performance standards for those terms.93 For example, when an advertisement or product package uses such terms as “degradable” or “biodegradable,”

[a]n unqualified claim that a product or package is degradable, biodegradable or photodegradable should be substantiated by competent and reliable scientific evidence that the entire product or package will completely break down and return to nature, i.e., decompose into elements found in nature within a reasonably short period of time after customary disposal. Claims of degradability, biodegradability or photodegradability should be qualified to the extent necessary to avoid consumer deception about: (1) the product or package’s ability to degrade in the environment where it is customarily disposed; and (2) the rate and extent of degradation.94

89 978 F.2d 1093 (9th Cir. 1992) (voice misappropriation in TV ad).90 Id. at 1111.91 FTC, FTC Approves Federal Register Notice on Advertising Endorsements and Testimonials, Nov. 21, 2008, available at http://www.ftc.

gov/opa/2008/11/endorsements.shtm; see also http://www.ftc.gov/os/2008/11/P034520endorsementguides.pdf.92 FTC, FTC Approves Federal Register Notice on Advertising Endorsements and Testimonials, supra note 91.93 FTC, Reporter Resources: The FTC’s Green Guides, available at http://www.ftc.gov/opa/reporter/greengds.shtm (last visited Mar. 17,

2009). The FTC is currently reviewing its Green Guides to determine whether they should be modified. The Green Guides were first issued in 1992 and modified in 1996 and 1998. The FTC has been reviewing the Green Guides since November 2007, but has yet to issue modifications as of November 2008. See also FTC, FTC: Eco in the Market: Green Guides Review, http://www.ftc.gov/bcp/edu/microsites/energy/about_guides.shtml (last visited Mar. 17, 2009). Note that FTC Guides are not binding and generally include the following statement: “This publication provides the FTC Staff’s view of the law’s requirements. It is not binding on the Commission.” See FTC, Facts for Business, Complying with the Environmental Marketing Guides, http:www.ftc.gov/bcp/edu/pubs/business/energy/bus42.shtm (last visited Mar. 17, 2009).

94 16 C.F.R. § 260.7 (2008).

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Likewise, manufacturers may mark a product or package as “recyclable” only “if it can be separated and collected from household and commercial trash for reuse, or to make another product or package, through an established recycling program.”95 Furthermore, advertisers may only claim that a product or package is recycled or contains recycled content if “it is made with materials that have been recovered or separated from the trash during the manufacturing process (pre-consumer) or after consumer use (post-consumer).”96 The FTC lists previously used newspapers, shipping cartons, plastic bottles, glass containers, and metal cans as examples of post-consumer waste, and leftover manufacturing scraps as pre-consumer waste. If a product contains used, reconditioned, or remanufactured parts, and an advertiser chooses to label the product as “recycled,” “the label also must say the product is ‘used,’ ‘reconditioned’ or ‘remanufactured’ unless that fact is obvious to the buyer.”97 It is also important to note that, before labeling a product “recycled,” manufacturers must indicate the percentage of recycled content, unless it is 100%.98 Lastly, use of the universal recycling symbol indicates that a product is both recyclable and made of recycled materials.99 If either of the two indications is untrue, the advertiser must indicate which does not apply.100

2. “Free”

Nothing attracts consumers quite like a bargain or deal. Offers of “free,” “two for the price of one,” “buy one, get one free,” and other similar statements used in advertising must adhere to strict guidelines to avoid running afoul of false advertising laws.

To this end, the Federal Trade Commission has issued a Guide Concerning Use of the Word ‘Free’ and Similar Representations.101 In that Guide, the FTC explicitly defines “free” in the context of advertising and sets the acceptable parameters within which the word can be used. For example, the free offer must be “based upon a regular price for the merchandise or service which must be purchased by consumers in order to avail themselves of that which is represented to be ‘Free.’”102 The FTC also provides a precise definition for “regular price:” “the price, in the same quantity, quality and with the same service, at which the seller or advertiser of the product or service has openly and actively sold the product or service in the geographic market or trade area in which he is making a ‘Free’ or similar offer in the most recent and regular course of business, for a reasonably substantial period of time.”103

The Better Business Bureau (“BBB”) has likewise adopted a definition of the term “free,” which the National Advertising Division (“NAD”) uses in deciding cases.104 That definition, contained in

95 FTC, FTC Consumer Alert: Eco-Speak: A User’s Guide to the Language of Recycling (July 1998), http://www.ftc.gov/bcp/edu/pubs/consumer/alerts/alt049.shtm (last visited Mar. 17, 2009).

96 Id.97 Id.98 Id.99 Id.100 Id.101 16 C.F.R. § 251.1 (2008).102 Id. § 251.1(b)(1).103 Id. § 251.1(b)(2).104 See discussion infra Part III for more information about the NAD.

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the Code of Advertising, states that the term may be used only when “the advertiser is offering an unconditional gift.”105 If the “free” item is conditional on a purchase, then this condition must be disclosed by the advertiser clearly and conspicuously next to the “free” offer.106 Small disclosures, like a mere asterisk next to the word, are considered inadequate.107 Like the definition in the FTC Guide, the BBB’s definition affirms that the normal price of the goods cannot be increased, nor can the quality or quantity of goods be reduced when offered in conjunction with the “free” offer.108 Finally, the definition requires that the “free” offer be temporary in nature.109

3. “New”

According to a widely-followed FTC advisory opinion, codified in the Code of Federal Regulations in 1967, a manufacturer should advertise a product as “new” only within the first six months of the product’s introduction into the market.110 In fact, the FTC has explicitly stated that “it would be inclined to question use of any claim that a product is ‘new’ for a period of time longer than 6 months.”111 The FTC nevertheless opted not to adopt a rigid rule, instead establishing “a tentative outer limit for use of the claim . . . leaving itself free to take into consideration unusual situations which may arise.”112 Despite this seemingly flexible approach, the FTC further noted that the “general rule would apply unless exceptional circumstances warranting a period either shorter or longer than 6 months were shown to exist.”113 Moreover, “[w]hen the word ‘new’ is used to denote an old product made from an improved formula or method, the advertising used should make clear that the word is used in that limited sense.”114

As a general matter, claims that a product is “new”—as opposed to used or recycled—should only be made in connection with merchandise that is “made throughout of new material and parts, has not been subjected to any use since completion of original manufacture, is unimpaired in appearance and condition, and is of a model or style of current manufacture.”115 If the product is not entirely new, it must have been “changed in a functionally significant and substantial respect.”116 “A product may not be called ‘new’ when only the package has been altered or some other change made which is functionally insignificant or insubstantial.”117 In the context of textiles, the fabric cannot be

105 2 do’S & don’tS in adveRtiSinG § 19 at 275–280 (Council of Better Business Bureaus 1996).106 Id.107 Id.108 Id.109 Id.110 Permissible Period of Time During Which New Product May Be Described as “New,” 16 C.F.R. § 15.120(d) (1967); see also Facts for

Business: Frequently Asked Questions: A Guide for Small Business (Apr. 2001), available at http://www.ftc.gov/bcp/edu/pubs/business/adv/bus35.shtm.

111 16 C.F.R. § 15.120(d), supra note 110.112 Id.113 Id.114 do’S & don’tS in adveRtiSinG, supra note 105, § 19 at 1054.115 Id. at 1052.116 15 C.F.R. § 15.120(b) (1967).117 Id. § 15.120(b).

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“new” if it has been reclaimed or respun.118 Likewise, when advertising tires, the use of the word is prohibited if the tires are retreads.119

Notably, advertised products are presumed to be “new,” even if they are not so labeled. Full disclosure must be made that “merchandise is used, second-hand, rebuilt, remanufactured, reconditioned, repaired, overhauled, or repossessed,” as the FTC considers concealment of such facts to be an unfair trade practice.120

4. “Made in the U.S.A.”

In 1997, the FTC promulgated the Enforcement Policy Statement on U.S. Origin Claims that requires “all or virtually all” of a product to be made in the United States before any advertising or labeling of the product as “Made in the U.S.A.” is permitted.121 To help advertisers understand the requirements of this labeling, the FTC also released a Business Guide that provides details and explanations for compliance with the “Made in the U.S.A.” standard.122

Like other advertising claims, claims that a product is made in the United States can be either express or implied. Claims that a product is a “product of the U.S.A.” or that products are “American-made” are express, while the inclusion of the United States flag or a map of the United States on a product’s label, or even an address with U.S. headquarters, can constitute implied claims that the product is made in the United States.123

In evaluating goods under the “all or virtually all” standard, the FTC “focuses on the overall impression of the advertising, label, or promotional material.”124 Taking this into consideration and focusing on important considerations for consumers, a product must have been “last substantially transformed in the U.S. into its marketable form” to satisfy the “Made in the U.S.A.” standard. Although this factor is primary, other considerations such as proportion of U.S. manufacturing costs, and how far removed the foreign content is from the finished product are also evaluated.125

Even if a product does not fulfill the requirements above, the FTC allows advertisers to make “qualified” “Made in the U.S.A.” claims. These claims must describe “the extent, amount or type of a product’s domestic content or processing” and indicate that a product is not entirely of United States origin.126 For example, claims that a product is “made in the U.S.A. of U.S. and imported

118 Facts for Business, supra note 110.119 Id. 120 do’S & don’tS in adveRtiSinG, supra note 105, § 19 at 1052.121 Enforcement Policy Statement on U.S. Origin Claims (Dec. 1997), available at http://www.ftc.gov/os/1997/12/epsmadeusa.htm.122 FTC, Facts for Business, Complying with the Made in the U.S.A. Standard, available at www.ftc.gov/bcp/edu/pubs/business/adv/bus03.

shtm.123 Id.124 5 J. thoMaS MCCaRthY, MCCaRthY on tRadeMaRkS & unfaiR CoMPetition § 29:54.50 (4th ed. 2008). See also FTC, FTC To Retain “All

or Virtually All” Standard for “Made in USA” Advertising and Labeling Claims, available at http://www.ftc.gov/opa/1997/12/musa2.shtm.

125 FTC, FTC To Retain “All or Virtually All” Standard, supra note 124.126 Id.

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parts” or “assembl[ed] in the U.S. of foreign components” are acceptable qualified claims. Just as with any other “Made in the U.S.A.” claim, a qualified claim must be truthful and substantiated.127

5. “Organic” Food Products

As a result of increased public awareness of the need for healthier products and lifestyles, the United States Department of Agriculture (“USDA”) in 2002 created the “USDA Organic” seal for use on labels and packaging of eligible food products. To qualify for use of this label, a food product must comply with national standards set forth by the USDA under its National Organic Program.128 Developed in part based on recommendations of the National Organic Standards Board and public comment, the USDA regulations generally divide eligible food and food products into three categories.129

If a product contains only organically-produced ingredients, excluding added water and salt, advertisers may use “100 percent organic” and the “USDA Organic” seal on labels and advertising for that product.130 If the food or food product consists of at least 95% organically-produced ingredients, again excluding water and salt, and the remaining 5% of ingredients are “nonagricultural substances approved on the National List or non-organically produced agricultural products that are not commercially available in organic form,” then manufacturers are permitted to use the term “organic,” as well as the “USDA Organic” seal.131 In the last category of organic products, those food products that contain at least 70% organic ingredients, the label “made with organic ingredients” may be used, but the “USDA Organic” seal is prohibited.132

If a product contains less than 70% organic ingredients, advertisers are not allowed to use the term “organic” on any packaging or advertising associated with that product. Nevertheless, if individual organic ingredients are included in the product, those ingredients can be designated as “organic” on the ingredient list of the product packaging.133

As a note of caution, advertisers should comply strictly with the above labeling requirements, as a civil penalty of up to $11,000 can be assessed on anyone who “knowingly sells or labels as organic a product that is not produced and handled in accordance with the National Organic Program’s regulations.”134

127 Id.128 See National Organic Program: Program Overview, available at http://www.ams.usda.gov/AMSv1.0 (follow link to “National Organic

Program” from main page).129 Susan J. Keri & Elisabeth A. Langworthy, “Organic” – Says Who?, INTA Bulletin, Vol. 61, No. 13 (July 15, 2006); National Organic

Program: Organic Labeling and Marketing Information (April 2008), available at http://www.ams.usda.gov/AMSv1.0/getfile?dDocName=STELDEV3004446&acct=nopgeninfo [hereinafter Organic Labeling and Marketing Information].

130 See Organic Labeling and Marketing Information, supra note 129; National Organic Program: Labeling Packaged Products, Jan. 2003, http://www.ams.usda.gov/AMSv1.0/getfile?dDocName=STELDEV3004323&acct=nopgeninfo (last visited Mar. 17, 2009).

131 Organic Labeling and Marketing Information, supra note 129.132 Id.133 Id.134 Id.

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III. The National Advertising Division: An Alternative to Litigating False Advertising Disputes

The National Advertising Division is a part of the National Advertising Review Council, which was formed in 1971 through the combined efforts of the Association of National Advertisers, the American Association of Advertising Agencies, the American Advertising Federation, and the Council of Better Business Bureaus, with a purpose to ensure accurate national advertising through self-regulation by parties.135 The NAD reviews advertisements on its own initiative, and contacts advertisers to request information to assess whether the advertisements are truthful and adequately supported. In addition, competitors and consumers can bring NAD proceedings challenging advertisements they believe to be false, misleading, or inadequately supported.

The NAD provides several advantages to litigating false advertising disputes in the courts. For one thing, it is much less expensive and decisions generally take just a matter of months. From the advertiser’s perspective, another advantage is the opportunity to submit proprietary and confidential information to the NAD without having to disclose that information to the challenger, as would be required in traditional litigation. Further, the NAD can choose to exercise its discretion in determining whether survey or other consumer perception evidence is necessary to establish that a literally true claim nevertheless is misleading, whereas there is no such discretion in traditional litigation.

The NAD process is not without drawbacks, however. For a challenger, one disadvantage may be the lack of any opportunity to conduct discovery and potentially uncover helpful evidence for its challenge. Moreover, the NAD’s recommendations are not binding on parties, although if a party refuses to participate in the NAD self-regulatory process, or if a party that has participated in this process later refuses to follow the NAD’s recommendations, the NAD will likely refer the claim to the FTC for enforcement.

For those seeking a quick and relatively inexpensive resolution of an advertising dispute, the NAD provides a good avenue. Moreover, challengers are free to file suit in court if resolution in the NAD proves unsatisfactory or if a party refuses to comply with the NAD’s recommendations.

IV. Conclusion

The scope of advertising law, and the challenges it presents to advertisers, is broad and varied. Before deciding to go forward with any proposed advertisement, whether in print, on television, online, or through any other medium, advertisers should ensure that their advertisement, taken as a whole, conveys only truthful and verifiable messages to consumers. It is prudent to consider the topics discussed above as a starting point, and to consult an attorney to ensure compliance with all aspects of advertising law.

135 See National Advertising Review Council, NARC Partners, http://www.narcpartners.org/about/partners.aspx (last visited Mar. 17, 2009).

KILPATRICK STOCKTON

Appendix A: Online Resources

For more information, please visit the following online resources:

Federal Trade Commission http://www.ftc.gov

FTC Division of Advertising Practices http://www.ftc.gov/bcp/bcpap.shtm

FTC Advertising Guides and Policy Statements http://www.ftc.gov/bcp/menus/resources/guidance/adv.shtm

FTC Green Guides http://www.ftc.gov/bcp/grnrule/guides980427.htm http://www.ftc.gov/opa/reporter/greengds.shtm

Memorandum of Understanding Between the FTC and the F.D.A. (1971)

http://www.ftc.gov/bcp/menus/resources/guidance/36FR18539.pdf

National Advertising Division of the Council of Better Business Bureaus

http://www.nadreview.org

Better Business Bureau: Code of Advertising http://us.bbb.org/us/code-of-advertising

Commercial Practices, C.F.R. Title 16, Chapter 1: Federal Trade Commission, parts 0-901

http://ecfr.gpoaccess.gov (search for Title 16)

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

OTHER TOPICS

Applicability of the Common Interest Doctrine for Preservation of Attorney-Client Privileged Materials Disclosed During Intellectual Property Due Diligence Investigations

Michael Pavento, Daniel H. Marti, Tracie Siddiqui, and Patrick Eagan

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Applicability of the Common Interest Doctrine for Preservation of Attorney-Client Privileged Materials Disclosed During Intellectual Property Due Diligence InvestigationsMichael Pavento, Daniel H. Marti, Tracie Siddiqui, and Patrick Eagan*

Technology permeates today’s business culture. As a result, most corporate transactions involve significant issues relating to the ownership, value, and use of technology and intellectual property rights. Many corporate transactions are driven by the underlying technology and intellectual property assets themselves, as parties seek to capitalize on the value and synergies that can result from buying, selling, licensing, and financing such assets. Consequently, prudent investors and acquirers conduct intellectual property due diligence investigations prior to consummating technology-driven corporate transactions.

A proper intellectual property due diligence investigation is designed to reveal defects or risks that may affect the value and/or structure of the proposed transaction. Such defects or risks can include, for example, encumbrances on the ownership of or right to use intellectual property assets, weaknesses or gaps in the protection afforded by intellectual property assets, actual or potential infringement by competitors, and exposure to third-party infringement claims. A company can undertake an intellectual property due diligence investigation, in large part, by using publicly available information and non-privileged confidential information. In some cases, however, the investigator may request access to previously prepared legal opinions and other information that is subject to the attorney-client privilege.

The ability to review attorney-client privileged information during a due diligence investigation can save the investigator significant time and money by reducing the need to conduct legal analyses that have already been done. In addition, access to privileged information can help the investigator understand and assess the nuances of a particular issue to a degree that might not otherwise be possible. As a general rule, however, disclosure of privileged information to a third-party will result in a waiver of the attorney-client privilege. Thus, disclosure of privileged information during a due diligence investigation may involve risks for both parties because it can result in a waiver of the attorney-client privilege regardless of whether the transaction is consummated.

An exception to the general rule that the attorney-client privilege is waived upon disclosure of privileged information to a third party is known as the “common interest doctrine.” Broadly stated, the doctrine holds that disclosure of privileged information to a third party will not result in a waiver if the third party has sufficient community of legal interest with the disclosing party. The common interest doctrine is most often recognized in cases involving joint clients (represented by the same attorney) or joint litigants (represented by the same attorney or different attorneys). However, some courts have also recognized the common interest doctrine in other contexts.

In considering whether the common interest doctrine applies in the context of a due diligence investigation, a central issue for the court to resolve is whether the asserted interest is legal and not

* The authors gratefully acknowledge the contributions of Nikkia Wharton to an earlier draft of this article.

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solely commercial.1 The answer to this inquiry is highly dependent upon the facts and circumstances of the case at hand and the prevailing jurisprudence within the relevant jurisdiction. Some courts have held that parties engaged in certain corporate transactions can share a common legal interest and should thus be allowed to exchange privileged information without effecting a waiver.2 Other courts have declined to extend the common interest doctrine to disclosures made during due diligence investigations, based on the notion that the parties to the underlying transactions are necessarily adversaries engaged in commercial negotiations.3

Accordingly, the question of whether a target company should produce privileged information in furtherance of an intellectual property due diligence investigation is one that should be carefully considered by both parties to the transaction. Conservatively, until the case law is more settled, the target company should produce privileged information only in those cases where the risk of a privilege waiver is clearly outweighed by the need for access, cost-savings, and/or efficiency. The remainder of this article highlights some of the more pertinent case law decisions in each federal judicial circuit and, as applicable, summarizes certain guiding principles for increasing the likelihood that a given disclosure will be protected.

I. First Circuit

Courts in the First Circuit follow the rule that the common interest doctrine applies only where the communication is made in the course of a common enterprise and in order to advance that common interest.4 A ‘common interest’ requires an identical (or nearly identical) legal interest, not simply a similar interest.5 While there do not appear to be any cases directly addressing the applicability of the common interest doctrine in the context of a due diligence investigation, the case of Cavallaro v. United States comes close.6 In that case, the District of Massachusetts considered whether the common interest doctrine could be applied to the disclosure of privileged documents discussing a proposed merger between two affiliated S corporations owned by members of the same family.

Although the Cavallaro court ultimately found that the common interest doctrine did not apply to the facts at issue because the recipient of the privileged information was not represented by counsel,7 the court did note that “[t]he weight of the case law suggests that, as a general matter, privileged information disclosed during a merger between two unaffiliated businesses would fall within the common-interest doctrine.”8 The court rejected the argument that the doctrine applies only when

1 See, e.g., Duplan Corp. v. Deering Milliken, Inc., 397 F. Supp. 1146 (D.S.C. 1974). 2 See, e.g., Hewlett-Packard Co. v. Bausch & Lomb, Inc., 115 F.R.D. 308, 309 (N.D. Cal. 1987); Tenneco Packaging Specialty &

Consumer Prods., Inc. v. S.C. Johnson & Son, Inc., No. 98 C 2679, 1999 WL 754748, at *2-3 (N.D. Ill. Sept. 14, 1999). 3 See, e.g., Corning Inc. v. SRU Biosystems, LLC, 223 F.R.D. 189 (D. Del 2004); Cheeves v S. Clays, Inc., 128 F.R.D. 128 (M.D. Ga.

1989).4 Coffin v. Bowater, Inc., No. 03-227-B-C, 2005 WL 1412116, at *4 (D. Me. June 14, 2005). 5 FDIC v. Ogden Corp., 202 F.3d 454, 461 (1st Cir. 2000) (citations omitted). 6 153 F. Supp. 2d 52 (D. Mass. 2001), aff’d, 284 F.3d 236 (1st Cir. 2002).7 Id. at 62 (citing Bank Brussels Lambert v. Credit Lyonnais, 160 F.R.D. 437, 447 (S.D.N.Y. 1995)) (“[T]he doctrine applies where parties

are represented by separate counsel but engage in a common legal enterprise.”). 8 Cavallaro, 153 F. Supp. 2d at 62 (citing Hewlett-Packard Co., 115 F.R.D. 308, 311 (N.D. Cal. 1987); United States v. Gulf Oil Co.,

760 F.2d 292, 296 (Temp. Emer. Ct. App. 1985) (holding that common-interest doctrine privileges communications between potential merger partners); Rayman v. Am. Charter Fed. Sav. & Loan Ass’n, 148 F.R.D. 647, 655 (D. Neb. 1993)).

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the parties anticipate litigation.9 In support, the Cavallaro court quoted the Northern District of California as follows:

[C]ourts should not create procedural doctrine that restricts communication between buyers and sellers, erects barriers to business deals, and increases the risk that prospective buyers will not have access to important information that could play key roles in assessing the value of the business or product they are considering buying.10

Although the Court of Appeals for the First Circuit has yet to ratify such broad language, the district courts within the circuit have been among the most amenable to assertions of privilege.

II. Second Circuit

As applied by district courts in the Second Circuit, the common interest doctrine prevents waiver of a privilege if the party invoking the doctrine demonstrates that the parties: (1) had a common legal interest, not merely a commercial one; and (2) the information was disclosed in the course of establishing a common legal strategy.11 A claim resting on the common interest doctrine requires a showing that the company gave the communication in confidence and that the client reasonably understood it to be confidential. Merely sharing a desire to succeed in an action does not create a common interest.12

In addressing whether the common interest doctrine applied to legal opinions exchanged during the course of a due diligence investigation, the Southern District of New York has suggested that the timing of the exchange can be a factor in determining whether the interest at issue is legal or commercial.13 In JA Apparel Corp., the plaintiff disclosed opinion letters to its eventual purchaser and parent company. The court reasoned that if the plaintiff disclosed opinion letters before the purchaser decided to acquire the company, disclosure may have waived any privilege because the letters’ creation and disclosure were motivated not by legal concerns, but by business concerns – namely, the valuation of the acquired company.14 Conversely, if the plaintiff disclosed opinion letters after the purchaser “had already made the decision, for all intents and purposes, to purchase [the acquired company], in order to better understand [the acquired company]’s rights and obligations under the relevant agreements,” disclosure may have served a legal purpose.15

As in the First Circuit, the lack of concrete appellate precedent requires a measure of caution, but the test laid out in JA Apparel provides the practitioner with certain guidance as to the direction or judicial leanings of certain district courts in the Second Circuit.

9 Cavallaro, 153 F. Supp. 2d at 62 (internal quotation marks omitted).10 Id. (quoting Hewlett-Packard Co., 115 F.R.D. at 311).11 Sokol v. Wyeth, Inc., No. 07 Civ. 8442, 2008 WL 3166662, at *5 (S.D.N.Y. Aug. 4, 2008); Gulf Islands Leasing, Inc. v. Bombardier

Capital, Inc., 215 F.R.D. 466, 471 (S.D.N.Y. 2003) (citation omitted). 12 Cendant Corp. v. Shelton, No. 3:06CV00854, 2007 WL 2460701, at *2-3 (D. Conn. Aug. 24, 2007).13 JA Apparel Corp. v. Abboud, No. 07 Civ. 7787, 2008 WL 111006, at *4 (S.D.N.Y. Jan. 10, 2008).14 Id. at *4 (citing In re Grand Jury Subpoena Duces Tecum Dated Sept. 15, 1983, 731 F.2d 1032, 1037 (2d Cir. 1984)). 15 JA Apparel Corp., 2008 WL 111006, at *4 (citing Stratagem Dev. Corp. v. Heron Int’l N.V., 153 F.R.D. 535, 543 (S.D.N.Y. 1994)).

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III. Third Circuit

Courts in the Third Circuit have generally held that the parties to a disclosure need only demonstrate that the shared interest is similar, not identical, in order for the common interest doctrine to apply.16 However, there is another line of cases in the Third Circuit in which courts have apparently looked to precedents in other circuits in holding that the nature of the common interest must be identical.17 It is unlikely that this uncertainty will be eliminated without appellate intervention.

As in other circuits, courts in the Third Circuit hold that the common interests of the parties must transcend similar commercial interests and involve common legal interests.18 Although the decisional law is thin, courts in the Third Circuit have suggested that the common interest doctrine applies in transactional contexts, such as when parties are jointly developing patents or contemplating a merger.19 In Katz v. AT&T Corp., however, the court held that documents relating to prior patent license negotiations between the co-plaintiffs were not subject to the attorney-client privilege under the common interest doctrine.20 Although the co-plaintiffs eventually consummated a licensing arrangement, the court found that the common interest doctrine did not apply to the documents in question “because the parties had not reached an agreement, final or otherwise, as to the licensing issues prior to the signing of the [license] agreement.”21 Although the court recognized that an executed agreement is not a prerequisite to application of the common interest doctrine, the court nonetheless concluded that the co-plaintiffs did not share an identity of legal interests when they were negotiating their license agreement at arm’s length.22 In the absence of concrete steps towards a final agreement, the parties’ legal interest were still sufficiently distinguishable to preclude protection.23

In defining the limits of the common interest doctrine, district courts within the Third Circuit have employed what appears to be less expansive language than have district courts in other circuits. Until case law is further developed within this circuit, it is advisable to proceed with extreme circumspection.

16 See La. Mun. Police Employees Ret. Sys. v. Sealed Air Corp., 253 F.R.D. 300, 309-10 (D.N.J. 2008) (“Although the most common statement of the degree of interest required is that ‘the interest be identical, not similar, and be legal, not solely commercial,’ the Third Circuit has not specifically adopted such a stringent approach.”) (citations omitted); Andritz Sprout-Bauer, Inc v. Beazer East, Inc., 174 F.R.D. 609, 634 (M.D. Pa. 1997) (“The interests of the parties need not be identical, and may even be adverse in some respects.”); Teleglobe Commc’ns Corp. v. BCE, Inc., 493 F.3d 345, 364-66 (3d Cir. 2007) (holding that the members of the community of interest must share at least a substantially similar legal interest, which need not be identical); In re Total Containment, Inc., No. 04-13144, 2007 WL 1775364, at *6 (E.D. Pa. June 18, 2007).

17 See Grider v. Keystone Health Plan Cent., Inc., No. 05-MC-40, 2005 WL 2030456, at *6 (M.D. Pa. July 28, 2005) (citing In re Regents of the Univ. of Cal., 101 F.3d 1386, 1390 (Fed. Cir. 1996)) (citation omitted).

18 In re Total Containment, Inc., 2007 WL 1775364, at *6. 19 Teleglobe Commc’ns, 493 F.3d at 364-66; Cargill, Inc. v. LGX LLC, No. 00-4252, 2007 WL 2142355, at *3 (E.D. Pa. July 23, 2007). 20 191 F.R.D. 433 (E.D. Pa. 2000).21 Id. at 438. 22 Id. 23 Id.

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IV. Fourth Circuit

In the Fourth Circuit, the interest must be legal in nature for the common interest doctrine to apply to any information shared among the parties.24 The party invoking the common interest doctrine must establish that the disclosure of privileged information was made as part of a common legal effort.25 Thus, “[i]n determining the applicability of the privilege, the focus is not on when [the] documents were generated, but on the circumstances surrounding the disclosure of [the] privileged documents to a jointly interested third party.”26 It is not necessary that there be actual litigation in progress for this privilege to apply.27

To date, the Fourth Circuit does not appear to have extended the common interest doctrine to cover privileged information disclosed in connection with due diligence investigations. The Fourth Circuit has not, on the other hand, ruled out such an application, and there is no reason to believe that the doctrine would not apply if the disclosure is clearly made in advance of such common legal, and not commercial, interests.

V. Fifth Circuit

In the Fifth Circuit, the two types of communications protected under the common interest doctrine are: (1) communications between co-defendants in actual litigation and their counsel, and (2) communications between potential co-defendants and their counsel.28 These oft-cited categories of protected communications are quite narrow when compared to the limits established in other circuits, and thus district courts in this circuit may arguably be reluctant to extend the common interest doctrine any further, even if the previously recognized categories of protected communications are found to be illustrative, and not exhaustive.

For communication between potential co-parties to be covered by the doctrine, the Fifth Circuit generally requires a “palpable threat of litigation at the time of the communication.”29 A financial interest in the outcome of litigation is an insufficient basis for finding a common legal interest.30 A common interest may exist between co-defendants, an insurer and insured, and a patentee and licensee.31

In Power-One, Inc. v. Artesyn Technologies, Inc., the court extended the common interest doctrine to communications between the defendant and a number of other power supply companies that

24 Neuberger Berman Real Estate Income Fund, Inc. v. Lola Brown Trust No. 1B, 230 F.R.D. 398, 416 (D. Md. 2005) (citing United States v. Aramony, 88 F.3d 1369, 1392 (4th Cir. 1996)).

25 Neuberger Berman, 230 F.R.D. at 416. 26 Id. at 416 (internal quotations omitted).27 Hanson v. United States Agency for Int’l Dev., 372 F.3d 286, 292 (4th Cir. 2004).28 In re Sante Fe Int’l Corp., 272 F.3d 705, 710 (5th Cir. 2001) (citations omitted); see also Ferko v. NASCAR, Inc., 219 F.R.D. 403, 405-

06 (E.D. Tex. 2003).29 Power-One, Inc. v. Artesyn Techs., Inc., No. 2:05cv463, 2007 WL 1170733, at *2 (E.D. Tex. Apr. 18, 2007) (quoting In re Sante Fe

Int’l, 272 F.3d at 710); Hill v. Hunt, No. 3:07-cv-02020, 2008 WL 4108120, at *7 (N.D. Tex. Sept. 4, 2008); FTC v. Think All Publ’g, LLC, No. 4:07-cv-011, 2008 WL 687456, at *1 (E.D. Tex. Mar. 11, 2008).

30 Stanley v. Trinchard, No. 02-1235, 2005 WL 399460, at *4 (E.D. La. Feb. 16, 2005). 31 Hill, 2008 WL 4108120, at *7.

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had been jointly developing certain technology.32 The power supply companies had entered into a common interest agreement prior to exchanging privileged legal analyses regarding one of the plaintiff’s patent applications. The court held that the power supply companies had a common legal interest insofar as they were all concerned about the plaintiff’s patents rights and their effect on the jointly developed technology.33

It is unclear whether the court would have reached the same conclusion without a clear and recognizable source of litigation, such as in the context of a merger. Given the Fifth Circuit’s narrow definition of the common interest doctrine generally, the practitioner may be well-advised to proceed under the assumption that the doctrine will not have broad effect in the field of due diligence, especially where the disclosures do not otherwise comport with the limited conditions recognized in other circuits.

VI. Sixth Circuit

The Sixth Circuit follows the more restrictive line of cases involving the common interest doctrine, but provides a relatively detailed framework within which information may be disclosed without waiver of privilege. The doctrine applies to the disclosure of privileged communications to a third party only when the third party is represented by counsel, the third party understands the significance of the communications’ privileged status, and the attorney making the disclosure takes affirmative steps to safeguard the privilege.34 The legal interests implicated by the disclosure must be identical.35 Litigation need not be actual or imminent for the common interest doctrine to apply.36 The common interest doctrine may also apply “in connection with patent rights.”37 Mere concern about litigation in the context of a commercial transaction, however, is not a sufficient legal interest to implicate the common interest doctrine.38

In Dura Global, Technology, Inc. v. Magna Donnelly Corp., the Eastern District of Michigan applied the common interest doctrine to two legal opinions regarding intellectual property rights.39 The party seeking common interest protection had taken steps to protect the confidentiality of the letters by marking letters as confidential and privileged, and ensuring that the recipient did not further disclose the information therein.40 The parties only shared information between intellectual property attorneys. The court further found that parties discussed the letters in connection with a common legal strategy rather than a joint commercial venture because the communications were exclusively about intellectual property issues rather than general business matters relating to the third parties’

32 2007 WL 1170733 at *2. 33 Id.34 Libbey Glass, Inc. v. Oneida, Ltd., 197 F.R.D. 342, 347-49 (N.D. Ohio 1999). 35 Dura Global, Techs., Inc. v. Magna Donnelly Corp., No. 07-cv-10995, 2008 WL 2217682, at *1 (E.D. Mich. May 27, 2008). 36 Id. at *3. 37 Fresenius Med. Care Holdings, Inc. v. Roxane Labs., Inc., No. 2:05-cv-0889, 2007 WL 895059, at *3 (S.D. Ohio Mar. 21, 2007)

(citations omitted). 38 Libbey Glass, 197 F.R.D. at 348.39 2008 WL 2217682, at *2-3. 40 Id.

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purchase.41 Finally, the demonstrable legal interest was potential patent infringement, not the larger commercial interest in which it was possible.42

In Fresenius Medical Care Holdings, Inc., the court held that a buyer’s interest in obtaining a valid patent sufficed to create a legal interest, despite the fact that communications about patent validity contributed to a commercial transaction.43 It was immaterial that the disclosure took place only after the closing, because the acquiring company’s legal interest in the validity of the patent “clearly survived the execution of the Asset Purchase Agreement . . . .”44 This contrasts with the Libbey Glass case, in which the failure to safeguard the confidentiality of the disclosures and the disclosure of legal advice to those whose relationship to the transaction in question was purely commercial precluded the application of the common interest doctrine.45

VII. Seventh Circuit

Although the Seventh Circuit has held that the common interest doctrine applies even without impending litigation, precedent indicates that the doctrine may not broadly serve to protect information shared during IP due diligence. Generally, like in other circuits, courts in the Seventh Circuit have held that the common interest doctrine applies only in situations where the interest is identical, not merely similar, and legal, not solely commercial.46 Although the common interest doctrine often arises in the context of documents shared between joint parties to litigation, courts in this Circuit have recognized that “litigation or impending litigation is not a prerequisite for the existence of a community of legal interests; corporations seek legal advice in order to plan their conduct and avoid litigation as well as to deal with present or impending litigation, and a community of legal interest may arise in the former situation as well as in the latter.”47

In Baxter Travenol Laboratories, Inc. v. Abbott Laboratories, the Northern District of Illinois found that communications relating to the prosecution and litigation of patents were protected by attorney-client privilege despite disclosure to two individuals with whom the defendant had contracted to jointly develop the patents.48 The court reasoned that co-developers of patents could have a community of legal interests because “they have a common legal interest in developing the patents to obtain greatest protection and in exploiting the patents.”49 However, the court refused to apply the common interest doctrine to communications relating to the parties’ rights among themselves or to documents shared during negotiations between the parties because “any mutual interest they may have had was tenuous.”50 The parties had signed disclosure agreements for information disclosed

41 Id. 42 Id.43 2007 WL 895059, at *3. 44 Id. 45 197 F.R.D. at 349.46 See, e.g., In re JP Morgan Chase & Co. Sec. Litig., No. 04 C 6592, 2007 WL 2363311, at *4 (N.D. Ill. Aug. 13, 2007).47 Baxter Travenol Labs., Inc. v. Abbott Labs., No. 84 C 5103, 1987 WL 12919, at *1 (N.D. Ill. June 19, 1987). 48 Id. at *1 (citing S.C.M. Corp. v. Xerox Corp., 70 F.R.D. 508, 514 (D. Conn. 1976)).49 Id.50 Id. at *2.

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during the negotiations, but the court stated that these agreements alone were not sufficient to establish a community of interest.51

In the due diligence area, the plaintiff in Tenneco Packaging Specialty & Consumer Products, Inc. v. S.C. Johnson & Son, Inc., sought production of a patent opinion obtained by DowBrands that had been shared with S.C. Johnson as part of due diligence for an asset purchase agreement in which S.C. Johnson acquired the rights in the patent.52 The plaintiff claimed that the disclosure eliminated the attorney-client privilege, but the defendant asserted that the document remained privileged under the common interest doctrine.53 Citing Baxter Travenol, the Northern District of Illinois held that the opinion was privileged and did not need to be produced.54 The court stated that the opinion was disclosed “when the asset purchase deal was largely locked up” and only to a limited number of S.C. Johnson employees who had “acknowledge[d] that the disclosure was subject to a confidentiality agreement.”55

In contrast, in In re JP Morgan Chase & Co. Securities Litigation, the Northern District of Illinois held that pre-merger documents shared between unaffiliated organizations were not protected by the common interest doctrine.56 Notably, the court did not cite Tenneco, and the party seeking protection based its arguments on “two non-controlling cases” from other circuits.57 The court reasoned that prior to the merger, the organizations stood on opposite sides of the business transaction, and their interests were in conflict because if one gained a better deal, the other suffered.58 The court stated that this lack of shared legal interest was demonstrated by the fact that it would have been unethical for a single attorney to represent both parties in the transaction.59 However, the court applied the attorney-client privilege to documents shared after the parties signed the merger agreement, because at that time “the parties . . . shared a common interest in ensuring that the newly agreed merger met any regulatory conditions and achieved shareholder approval.”60

The holdings in Tenneco and JP Morgan Chase, therefore, are somewhat inconsistent. This inconsistency may turn on the facts that the Tenneco deal was “largely locked up” and the disclosure was expressly limited to certain parties. Although the Northern District of Illinois has not signaled a clear intent to move away from its earlier Tenneco case, the JP Morgan Chase decision appears to create a more modern and unfavorable precedent for any party seeking to use the common interest doctrine to protect confidential information disclosed during due diligence investigations in the Seventh Circuit.

51 Id.52 No. 98 C 2679, 1999 WL 754748, at *2 (N.D. Ill. Sept. 14, 1999).53 Id.54 Id.55 Id.56 No. 06 c 4674, 2007 WL 2363311, at *3 (N.D. Ill. Aug. 13, 2007). 57 Id. at *5.58 Id. 59 Id.60 Id.

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VIII. Eighth Circuit

Like courts in other circuits, courts in the Eighth Circuit follow the rule that the common interest doctrine applies when “the legal interest [is] identical, not similar, and [is] legal, not solely commercial.”61

In Rayman v. American Charter Federal Savings & Loan Ass’n, the District Court for the District of Nebraska held that documents analyzing pending litigation that were revealed in merger negotiations remained privileged despite the disclosure.62 The court held that at the time of the negotiations, it was clear that if the merger were completed, the party to whom the information was revealed would be defending the action.63 Therefore, the parties had a common legal interest, namely the identical issues of law and fact in the pending case.64 The court found that not requiring disclosure was the better result because the information that was concealed (defense counsel’s analysis of the case, the present posture of the action, the estimated cost of defending the suit, and expenses incurred to date) did not leave the requesting party in a worse position than if disclosure had taken place.65 In addition, from a policy perspective, the court believed that an alternative result would harm business transactions between buyers and sellers.66 Therefore, although there is not much precedent in this area from courts in the Eighth Circuit, that which is available appears generally favorable to parties who wish to use the common interest doctrine to maintain privilege during IP due diligence investigations.

IX. Ninth Circuit

Courts in the Ninth Circuit have also held that the common interest doctrine applies when the nature of the interest between the parties asserting the privilege is identical, not similar, and is legal, not solely commercial.67 In Hewlett-Packard Co. v. Bauch & Lomb, Inc., the plaintiff sought a patent opinion letter for which it claimed the defendant had waived attorney-client privilege by showing the document to a non-party during asset purchase negotiations.68 The Northern District of California held that the common interest doctrine extended to the letter because the parties anticipated litigation in which they would have in common identical issues of fact and law.69

To justify its holding, the court evaluated a variety of policy implications of the holding. First, it stated that fear of waiver causes attorneys to spend excessive amounts of time and money screening documents and rehearsing witnesses.70 In addition, the court stated that analysis should distinguish between “partial” and “selective” disclosure.71 Partial disclosure, which causes waiver of the

61 Rayman v. Am. Charter Fed. Sav. & Loan Ass’n, 148 F.R.D. 647, 654 (D. Neb. 1993) (internal citations omitted).62 Id.63 Id.64 Id. 65 Id. at 655.66 Id.67 Hewlett-Packard Co. v. Bausch & Lomb, Inc., 115 F.R.D. 308, 309 (N.D. Cal. 1987). 68 Id.69 Id. at 310.70 Id.71 Id. at 311.

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privilege, occurs when a party “tries to use advantageous portions of the privileged information while shielding portions that might be harmful to their case.”72 In contrast, selective disclosure occurs when a party “shares an entire document with a selected, limited audience” and “upon conditions of and with regard for confidentiality.”73 The court said that selective disclosure should not waive the privilege.74

As an additional justification, the court reasoned that finding waiver in the context of business transactions could “make it appreciably more difficult to negotiate sales of businesses and products that arguably involve interests protected by laws relating to intellectual property.”75 Finally, the court was concerned about attorneys’ tendency to spend “an inordinate amount of time” trying to gain an advantage using the opposing party’s attorney’s statements, which it said leads to “costly, unproductive, and unseemly disputes.”76 Likely due to the depth of the court’s analysis, the Hewlett-Packard opinion is frequently cited in cases addressing the common interest doctrine in the context of due diligence investigations, even by courts outside of the Ninth Circuit.77

Relying on Hewlett-Packard, in BriteSmile, Inc. v. Discus Dental Inc., the Northern District of California found that a patent opinion letter that the defendant’s attorney had shared with the owner of the patent the defendant was purchasing was privileged under the common interest doctrine.78 The court held that the parties had a common interest in the outcome of the attorney’s analysis, which was focused on whether the patent infringed any patents or was itself patentable.79 Therefore, the court held that because of the parties shared interest in the sale of the technology, they did not waive the privilege when the disclosures were made under “a strict duty of confidentiality.”80

Not all cases from Ninth Circuit district courts have agreed with the Hewlett-Packard opinion’s fairly expansive interpretation of the common interest doctrine. In Nidec Corp. v. Victor Co. of Japan, the Northern District of California stated that “[t]o the extent Hewlett-Packard implies that policy consideration such as removing barriers to business deals expands to common interest doctrine and obviates the requirement that the protected communication must be intended to further the specific legal effort in which they hold a joint interest, the Court disagrees.”81 The Nidec court clarifies that Hewlett-Packard should not be interpreted to have permitted the common interest doctrine to preserve information as confidential simply because the third party with whom the information was shared was a prospective purchaser.82 Instead, it says, Hewlett-Packard should be interpreted as stemming from the common legal interest created by the anticipated joint litigation.83 Further

72 Id. 73 Id. 74 Id.75 Id.76 Id. at 311-12.77 See, e.g., Rayman, 148 F.R.D. at 654-55; Tenneco Packaging, 1999 WL 754748, at *2.78 No. C 02-3220 JSW (JL), 2004 WL 2271589, at *1 (N.D. Cal. Aug. 10, 2004). 79 Id. 80 Id.81 249 F.R.D. 575, 580 (N.D. Cal. 2007). 82 Id. at 579. 83 Id.

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narrowing the opinion, the Nidec court says that for communications to be protected, they must be designed to further the parties’ common legal interest, which would generally be a common defense strategy.84 Therefore, the Nidec court held that when information was shared with a prospective purchaser, but there was little to indicate that there might be joint litigation, there was no common interest.85

Therefore, although the Hewlett-Packard decision created very favorable precedent for district courts in the Ninth Circuit, the Nidec decision may limit the extent of its applicability to cases in which there is no litigation contemplated.

X. Tenth Circuit

There do not appear to be any cases from the Tenth Circuit that address the common interest doctrine in the specific context of an IP due diligence investigation; however, practitioners should be aware of the cases from this circuit that may be used as a foundation to extend or restrict the doctrine in the due diligence context.

Generally, the Tenth Circuit applies the joint defense privilege when the individual claiming the privilege can demonstrate that “(1) the documents were made in the course of a joint-defense effort; and (2) the documents were designed to further that effort.”86 Following this rule, in Static Control Components, Inc. v. Lexmark International, Inc., the District Court for the District of Colorado held that documents and information exchanged between the lawyers for two alleged patent infringers pursuant to a common interest agreement were protected from disclosure by the joint defense privilege.87 Although the defendants had revealed only documents related to their joint defense, the plaintiff argued that the parties’ legal interests did not coincide because one defendant had asserted a claim and served discovery on the other.88 The court held that “[e]ven if there is adversity between some of the parties to the common interest agreement, they still may invoke the joint defense privilege to protect communications from disclosure to third parties.”89

Similarly, in Sawyer v. Southwest Airlines, the District Court for the District of Kansas held that sharing attorney-client privileged documents between an insured and an insurer who were represented by the same attorney did not waive the privilege.90 In Sawyer, the court held that the insurer had a duty to defend the insured in the case, and therefore the parties had common legal,

84 Id.85 Id. 86 Grand Jury Proceedings v. United States, 156 F.3d 1038, 1042 (10th Cir. 1998)(refusing to apply the privilege because the relevant

party failed to produce any evidence, express or implied, of a joint-defense agreement, and he has failed to show how the documents at issue here furthered the putative joint-defense strategy).

87 250 F.R.D. 575, 579 (D. Colo. 2007). 88 Id.89 Id. at 579. 90 Nos. Civ.A.01-2385-KHV, Civ.A.01-2386-KHV, 2002 WL 31928442, at *3 (D. Kan. Dec. 23, 2002); cf. Carbajal v. Lincoln Benefit

Life Co., Civ. A. No. 06-cv-00884-EWN-KLM, 2007 WL 3407345, at *4-5 (D. Colo. Nov. 13, 2007) (holding that insurance companies that were represented by different attorneys in different but related litigation initiated by the same plaintiff did not waive the privilege when they shared information). But see Garcia v. Berkshire Life Ins. Co. of Am., No. 04-cv-01619-LTB-BNB, 2007 WL 3407376, at *8 (D. Colo. Nov. 13, 2007) (stating that Colorado only recognizes the common interest doctrine in “communications made between co-defendants and the attorney who represents them both, for the sake of discussing their common interests in a joint defense in civil or criminal litigation.”).

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not simply commercial, interests.91 Although the defendants in the Sawyer case had not explicitly asserted the common-interest doctrine, the court held that they had established the elements of that claim, namely that the parties had a common legal interest in securing legal advice related to the same matter and the communication was made to advance their interest in securing legal advice on that common matter.92

Therefore, the courts in the Tenth Circuit appear to generally be open to the assertion of the common interest doctrine, although there is no precedent that could establish a clear rule in the IP due diligence context.

XI. Eleventh Circuit

At least one court in the Eleventh Circuit has declined to apply the common interest doctrine to documents shared during negotiations of an asset purchase agreement. In Cheeves v. Southern Clays, Inc., the defendant shared attorney-client privileged information with a company when the company acquired the majority of the defendant’s assets.93 The acquiring company later shared this information with a third company that acquired the assets that had been purchased from the defendant.94 The Middle District of Georgia held that because (1) there had been no merger or de-facto merger from the asset sale, (2) the parties owed no duty to defend each other, and (3) the parties had not consulted the same attorney, there was no community of interest and therefore the disclosure waived the privilege.95

Courts in the Eleventh Circuit have applied the common interest doctrine in the more traditional case of co-defendants sharing litigation strategy, however. In Jeld-Wen, Inc. v. Nebula Glasslam International, Inc., the Southern District of Florida stated that “[u]nder the common interest doctrine, ‘litigants who share unified interests [may] exchange . . . privileged information to adequately prepare their cases without losing the protection afforded by the privilege.’”96 The court therefore held that when co-defendants revealed information to each other in the course of deciding a joint trial strategy, the work-product privilege had not been waived.97

Thus, courts in the Eleventh Circuit generally appear open to applying the common interest doctrine in the more common litigation context, but it may be difficult for parties to assert the doctrine in the context of information revealed during due diligence investigations, especially in a non-merger context or where a clear duty to indemnify is not provided.

XII. Guiding Principles

Given the case law summarized above, it is apparent that there is no bright-line rule regarding when or if the common interest doctrine will be applied to privileged information exchanged during the

91 2002 WL 31928442, at *3. 92 Id.93 128 FRD 128, 129 (M.D. Ga. 1989).94 Id.95 Id. at 130-31. 96 No. 07-22326-CIV, 2008 WL 756455, at *11 (S.D. Fla. Mar. 11, 2008).97 Id.

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course of an intellectual property due diligence investigation. Applicability of the common interest doctrine in these and other contexts varies from jurisdiction to jurisdiction and is highly dependent on the underlying facts and circumstances of the disclosure. However, one can discern guiding principles for increasing the likelihood that a court will apply the common interest doctrine in the due diligence context from some of the more commonly cited decisions directly addressing the issue.

(1) As a starting point, it is prudent to assume that disclosure of privileged information to a third party will result in a privilege waiver. Clients, and perhaps even the third parties with whom they are dealing, should be advised of the waiver risk and should be encouraged to share privileged information only when absolutely necessary. This guiding principle is particularly true in the context of any arms-length negotiation. Whenever possible, as an alternative to disclosure of privileged information, the par-ties should provide the due diligence investigator with sufficient non-privileged infor-mation to allow the investigator to conduct his/her own legal analysis of a particular issue.

(2) If a disclosure of privileged information is ultimately deemed necessary, the company should delay disclosure until it concludes substantive deal negotiations, or as near as possible. Delaying may help to minimize a natural assumption that the parties’ inter-ests are adverse when a corporate transaction is being negotiated.

(3) Similarly, although rarely a practical concern in the context of a due diligence in-vestigation, privileged information should not be exchanged unless both parties are represented by counsel.

(4) Any exchange of privileged information should be performed by and among lawyers, preferably intellectual property lawyers when the privileged information relates to matters of intellectual property law. Involving the lawyers in this fashion, and remov-ing corporate executives from the exchange of privileged information, can help to lay a solid foundation for an argument that the exchange was made in view of a common legal interest rather than a purely economic interest.

(5) Lastly, when privileged information is disclosed in a due diligence context, the parties should strongly consider executing a common interest agreement and/or a confidenti-ality agreement to demonstrate their mutual commitment to preserving the confidenti-ality and privileged status of the disclosed information and to memorialize any shared legal interests. To adequately protect the privilege, such an agreement should protect the confidentiality in perpetuity and forbid disclosure to unauthorized parties even if required by law. The agreement should also limit and/or specifically identify the people who are permitted to have access to the privileged information. Along the same lines, the agreement should restrict the number of copies that can be created and should affirmatively require the return to the disclosing party or destruction of all originals and copies. Whenever possible, the parties should elect to have their common inter-est agreement and/or confidentiality agreement governed by a jurisdiction with more

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favorable legal precedent regarding the applicability of the common interest doctrine, such as those jurisdictions most closely following the reasoning, if not precedent, of Hewlett-Packard Co. v. Bausch & Lomb, Inc. (Northern District of California).

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

OTHER TOPICS

Franchising Questions and Answers

Rupert M. Barkoff, Christopher P. Bussert, and Alexander G. Tuneski

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Franchising Questions and AnswersRupert M. Barkoff, Christopher P. Bussert, and Alexander G. Tuneski

I. Introduction

In the United States, sales of franchises are regulated by the Federal Trade Commission (“FTC”) and various state statutes and regulations. This article will review the applicable state and federal laws and regulations governing the sale of franchises and distributorships. This article will also review laws governing the franchise or distributorship relationship after the initial sale has been consummated. These laws often cover issues such as termination, renewal, and assignment rights.

Q. What is a franchise?

It is difficult to define succinctly what constitutes a franchise, but under the FTC’s Amended Franchise Rule (the “FTC Rule”)1 and most of the state registration laws, there are three key elements to a franchise:

(1) The franchisor and franchisee are mutually associated with a common trademark, logo, or trade name;

(2) The franchisor must promise to give the franchisee significant assistance or the fran-chisor must impose significant controls over the franchisee; and

(3) The franchisee is required to pay fees to the franchisor or its affiliates that will amount to over $500 during the first six months of the franchise relationship.

Substantively, state registration laws describe the definitional aspects of franchises in a similar manner, although the wording may appear quite different. Rather than talking in terms of “significant assistance” or “significant control,” most state statutes require that the franchisee be required to follow a prescribed or suggested “marketing plan,” or that a “continuity of interest” exist between the franchisee and the franchisor. In essence, the definitional differences between the FTC Rule and state statutes or regulations are not that significant, although that is not always the case.

Q. What is the difference between a franchise relationship and a trademark license?

A typical trademark licensing arrangement often satisfies most of the elements of the definition of a “franchise.” The trademark requirement is easily met, there is certainly some sort of license fee charged for use of the mark, and some controls are placed upon use of the mark. In fact, the Lanham Act virtually mandates that some control be imposed upon a licensee in order for the franchisor to retain the validity and ownership of the mark. These trademark controls alone, the FTC and state officials have stated, are not enough in themselves to create a franchise relationship. The difference between a trademark licensing relationship and a franchise relationship often turns on the amount of control that a franchisor exerts over a franchisee. Generally, the more assistance or control that a licensor exerts over its licensee, the more likely a relationship may be considered a franchise. But the lines of demarcation are quite gray.

1 The FTC’s former rule, entitled “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures” (“Franchise Rule”), was amended in 2007. 72 Fed. Reg. 15444 (Mar. 30, 2007), codified at 16 C.F.R. § 436.

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Determining whether a licensing relationship is a franchise relationship requires a fact-specific analysis of each contractual obligation of a proposed relationship. Significant types of control include: (1) providing site approval or site selection for unestablished businesses; (2) implementing site design or appearance requirements; (3) controlling hours of operation; (4) mandating production techniques; (5) mandating accounting practices or personnel policies; (6) requiring franchisee participation or financial contribution to promotional campaigns; and (7) restricting customers, locale, or area of operation. Significant types of assistance include: (1) providing formal sales, repair, or business training programs; (2) establishing accounting systems; (3) furnishing management, marketing, or personnel advice; (4) furnishing system-wide networks and website; and (5) furnishing a detailed operating manual.2

Generally, the following items do not constitute significant control or assistance: (1) implementing “trademark controls designed solely to protect the trademark owner’s legal ownership rights in the mark under state or federal trademark laws (such as display of the mark or right of inspection);” (2) “furnishing a distributor with point-of-sale advertising displays, sales kits, product samples, and other promotional materials intended to help the distributor in making sales;” (3) providing advertising in various media; (4) implementing “health or safety restrictions required by federal or state law or regulations;” and (5) “assisting distributors in obtaining financing to be able to transact business.”3

Q. Are there other types of relationships that might be subject to regulation?

Even if a relationship does not meet the definition of a franchise, it is possible that it could be considered a “business opportunity.”4 Business opportunities, which include sales of vending machines and rack displays, are regulated by a federal rule. A “business opportunity” is a continuing commercial relationship in which the seller arranges for the purchaser to obtain a supply of goods, commodities, or services, and secures for the purchaser retail outlets or accounts for the goods, commodities, or services, or secures for the purchaser locations or sites for vending machines, rack displays, or any other product sales displays used in the offer or distribution of goods, commodities, or services.5

Twenty-five states also have laws covering the sale of business opportunities, which are defined differently under each state statute.6 The state law definitions are often expansive enough to include traditional franchises or distributorships, as well as vending machines and rack displays. Accordingly, these statutes must be taken into account in setting up any franchise or distributorship arrangement.

2 Federal Trade Commission, Franchise Rule Compliance Guide 2–4 (2008), http://www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf.

3 Id. 4 See 16 C.F.R. § 437 (2008).5 Id. § 437.2(a)(1).6 See FTC, State Offices Administering Business Opportunity Disclosure Laws, http://www.ftc.gov/bcp/franchise/netbusop.shtm (last

visited Mar. 12, 2009).

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Distribution arrangements, too, are often subject to state franchise registration laws and the FTC Rule. While the trademark and control requirements are not usually the definitional aspects that create legal issues for distribution, the fee element can create controversy as to whether a distributorship will be classified as a franchise. Usually a distributor, unlike the classical franchisee, pays nothing up front to obtain his distribution rights, and the revenues from which the manufacturer will make his profit come solely from product markups. Both the FTC and all of the registration states have interpreted the term “franchise fee” broadly to include almost all revenue received by the franchisor or its affiliates from the franchisee, whatever the source. However, the term “franchise fee” has also been interpreted to exclude revenues derived from the sale of reasonable amounts of inventory in the ordinary course of business at bona fide wholesale prices. Thus, the traditional distributor who simply buys inventory from the manufacturer will not be deemed a franchisee. On the other hand, if the distributor is required to pay an up front fee, purchase excessive amounts of inventory, pay inflated prices for inventory, or purchase other items or services from the manufacturer or its affiliates, such as repair equipment or training, all of the federal and state regulatory burdens may apply.

II. Franchise Sales Laws

Q. How are franchise sales regulated?

Franchise sales are regulated at both the state and federal level. During the late 1960s, instances abounded in which franchisees, expecting to become part of valuable and well-respected chains, made considerable investments in business ventures only to find later that the rights they were granted were worthless and the costs involved in the purchase and operation of the franchise were considerably greater than anticipated. In many situations, expected gross or net income had been vastly exaggerated as well.

As a result of these instances, beginning in 1970, states took action to attempt to regulate the industry. Today, 15 states have franchise investment laws requiring pre-sale disclosures, including California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin.7 Although each of the state registration laws has its own peculiarities, the statutes are for the most part similar. All (1) contain definitions of the term “franchise,” (2) require franchises to be registered with designated state officials before being offered for sale, (3) require certain disclosures to be made to prospective franchisees, and (4) require a cooling-off period before the franchise offer may be accepted by a prospective franchisee. Each statute provides for civil and criminal remedies in the event a franchisor violates the statute. The civil remedies may be enforced either by designated state officials or by the affected franchisee.

In 1979, after almost a decade of investigation, the Federal Trade Commission, pursuant to Section 5 of the Federal Trade Commission Act, enacted its “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures” (the “Franchise Rule”). In 2007, the FTC approved amendments to the Franchise Rule. Like the original Franchise Rule, the amended

7 See FTC, State Offices Administering Franchise Disclosure Laws, http://www.ftc.gov/bcp/franchise/netdiscl.shtm (last visited Mar. 12, 2009). Michigan and Oregon do not require a filing of the pre-sale disclosures, also known as “offering circulars.” See 72 Fed. Reg. 15444, 15449 (Mar. 30, 2007).

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FTC Rule has many similarities with the state franchise registration statutes in that it requires certain disclosures to be made to prospective franchisees and requires a cooling off period before the franchise can actually be sold. However, two notable differences exist. First, there is no registration requirement under the FTC Rule. Second, there is no private right of action if the FTC Rule is violated. Only the FTC can bring civil or criminal actions if a franchisor fails to comply with the FTC Rule.

Q. How does the FTC Rule coexist with state sales statutes?

In states without franchise sales statutes, such as Georgia and North Carolina, franchisors must comply with the FTC Rule when selling franchises. In jurisdictions having registration statutes, such as New York, both the state statute and the FTC Rule must be adhered to before franchise sales can be commenced.

The FTC alleviated much of the complexity caused by dual levels of regulation by stating that its rule preempted state laws only to the extent that state laws provided less protection to prospective franchisees. Since most of the registration statutes afford greater protection to prospective franchisees, many of the problems created by dual federal and state regulation were eliminated.

States have also done their part to attempt to make most of their regulations more consistent with the requirements imposed by the Franchise Rule, and this consistency generally carries over to the amended FTC Rule. However, many states have retained their own idiosyncrasies which impose additional or different requirements on franchisors.

Q. Are there exemptions or exclusions available from the FTC Rule or state sales statutes?

Yes, both the FTC and the states have exempted or excluded certain activities or persons from the scope of regulation. The FTC Rule, for example, excludes certain types of relationships because they do not satisfy the three elements required to be a franchise: (1) single trademark and exclusive manufacturing agreements, (2) general partner relationships, (3) employer-employee relationships, (4) cooperative associations, and (5) certification or testing services arrangements.8 The FTC Rule provides for: (1) a large franchisee exemption (franchisee or an affiliate is an entity that has been in business for at least five years and has a net worth of at least $5 million); (2) a large franchise investment exemption (where at least one individual contributes a minimum of $1 million), (3) an exemption for franchise sales to insiders, (4) an exemption for department store leasing arrangements, (5) a fractional franchise exemption for franchisees that have more than two years of experience in that line of business, and sales from the new franchise line of business make up less than 20% of the business’s overall sales, (6) a minimum payment exemption where the required payment to the franchisor is less than $500 within the first six months, (7) an exemption for oral agreements for which there is no written evidence of a material term of the franchise relationship, and (8) an exemption for “petroleum marketers and resellers covered by the Petroleum Marketing Practices Act (“PMPA”).”9 State laws, depending upon the jurisdiction, may exempt or exclude

8 72 Fed. Reg. 15444, 15529–30 (Mar. 30, 2007).9 Id. at 15520–29, 15560.

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large franchisors, isolated sales, or sales by established franchisors. A franchise sale may be exempt from disclosure requirements at the state level, but not at the federal level, and vice versa.

III. Franchise Disclosures

Q. What must be disclosed to a prospective franchisee?

If a relationship meets the applicable state or federal definition of a franchise, the franchisor or its counsel must prepare a disclosure document known as a “Franchise Disclosure Document” (“FDD”), formerly known as a “Uniform Franchise Offering Circular” or “UFOC” until the 2007 revision of the FTC Rule. The FDD includes certain disclosures mandated by the FTC Rule and state statutes. While the form of the FDD is very similar among the various states, each state has its own peculiarities, which means that the document used to sell franchises in each registration state may be different in certain respects from that used in other jurisdictions. Typically, these state peculiarities are addressed in the form of addenda to the FDD and to related agreements so that a single FDD may be used in all fifty states.

Q. What is included in a FDD?

A FDD includes 23 Items and numerous exhibits. The body of a typical FDD can range from 30 to 50 pages. The entire FDD, including exhibits, often will be over 200 pages. Information relating to the franchise that must be found in the FDD includes, among other things, background information on the franchisor and its key management, officers, and directors; the amount of initial and subsequent franchise fees to be paid to the franchisor and its affiliates; the estimated cost to make the franchise operational; any requirements that the franchisee must purchase certain items from the franchisor or its affiliates or otherwise do business with designated suppliers; and a summary of certain material provisions of the franchise agreement (such as the term, renewal rights, restrictions on in-term and post-term competition, and territorial rights granted to the franchisee). Any agreements that are relevant to the franchise opportunity, such as the franchise agreement, must be included as exhibits to the FDD. Audited financial statements of the franchisor must also be included in the FDD, although the amended FTC Rule allows a phase-in period where a start-up franchisor does not need to include audited financial statements.

Q. Can a franchisor make representations or claims about a franchisee’s potential earnings?

Yes, if the information is included in Item 19 of the FDD. Item 19 includes “financial performance representations” (formerly known as “earning claims”) that a franchisor wishes to make about its franchise opportunity. A franchisor is not required to include any financial performance representations in its FDD. It is estimated that only 30% to 40% do so. However, with limited exceptions, a franchisor and its sales representatives may not make any other representations to a prospective franchisee about the earnings of other franchisees, projected earnings of franchises, or sales information, unless the representations are included in Item 19. Thus, if a franchisor does not include financial data in its FDD, the franchisor would be unable to answer questions regarding a franchisee’s potential income or earnings.

KILPATRICK STOCKTON

Financial performance representations included in Item 19 may be projections or based on historical results of existing outlets. In practice, the overwhelming majority of financial performance representations present data from existing outlets rather than projections. Data from subsets of outlets may be used, provided that appropriate disclosures are included that allow the franchisee to understand how representative the subset may be compared to the rest of the outlets in the system. There must be a reasonable basis for all claims made in Item 19 and a franchisor must be able to produce the data that was used to make the representations.

Q. When must a franchisor provide a FDD to a prospective franchisee?

Under the FTC Rule, a franchisor must provide its FDD to a prospective franchisee at least 14 calendar days before entering into any binding agreement with or receiving any payment from the franchisee. State rules may differ. In Maryland, New York, and Rhode Island, the FDD must be provided at the earlier of the first personal meeting or ten business days before the franchisee signs a binding agreement with, or makes a payment to, the franchisor.

IV. Franchise Registration

Q. What is the franchise registration process?

As stated above, there is no federal registration of franchise offerings. In the 13 states which require registration of franchise offerings, registration can be a difficult and often lengthy task that requires advanced planning by the franchisor and its legal counsel.10 The franchisor or his counsel must submit the FDD and various other forms to the appropriate state officials, typically the state’s Department of Corporations or Attorney General’s office. The entire package is referred to as the registration application. Registration applications must be accompanied by the applicable registration fee, which ranges from $250 to $750. Registrations are effective for one year and generally must be renewed before their expiration date. Renewal fees are usually approximately one-half of the initial registration fee.

Except in Indiana, Michigan, South Dakota, and Wisconsin (where the review process has been eliminated), the state officials are given a period of time—usually about 30 calendar days—to review the registration application and furnish comments to the franchisor. The franchisor must then respond to these comments, either by making the suggested changes, or by convincing the officials that their concerns are unwarranted and that no changes are necessary. While deficiencies can often be corrected with only one revision, it is not unusual for a franchise registration application to be revised two or more times before the state will register the offering and for the entire registration process to take two to three months from the date the registration application is first submitted for review. When the registration process is successfully completed, an order declaring the registration effective is issued by the state. The order does not indicate that the registration has been endorsed by the state, and any representation to that effect can be a criminal offense.

Q. Do states apply the same standards of review?

10 See http://www.ftc.gov/bcp/franchise/netdiscl.shtm. Two of the fifteen states that have franchise investment laws do not require filings.

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No. The review process by each state has traditionally been independently conducted, and because of other variations in state regulations, the different training programs given to franchise registration examiners, and in some cases the different philosophies of state officials toward review, the registration process can take different turns in each jurisdiction, thereby increasing the likelihood that the offering documents will be different in each state. In several jurisdictions, for example, the state officials may simply compare the submitted documents to their state statutes and regulations, and their comments will only reflect variations between the two. In other states, the examiners will give the FDD closer scrutiny and in some cases make comments about the merits of the offering itself. Oftentimes, changes requested by one state will result in a franchisor filing amendments in other states so that it can offer a single FDD in all states rather than having a handful of state-specific versions.

There are other differences among states in the registration process. All states can require that initial franchise fees be escrowed until the prospective franchisee’s business becomes operational, but not all will do so, even in identical factual settings. In many registration jurisdictions, franchise sales literature must be cleared by the state in advance. Again, different standards of review may be applied. The bottom line is that the offering documents and the registration process can vary considerably from state to state, making franchise-selling a cumbersome and expensive process.

V. Non-Compliance

Q. What are the penalties for non-compliance under the FTC Rule?

Failure to comply with the FTC Rule can have severe results. For violations of the FTC Rule, the penalty per violation has recently been raised to $16,000.11 Other remedies include equitable remedies, assessment of damages incurred by the public, and criminal sanctions.

In practice, the FTC has been viewed somewhat as a toothless tiger. Because of budget limitations and other factors, the FTC has not taken a very aggressive role in prosecuting FTC Rule violations. As a general rule, the FTC seriously investigates situations only when the franchisor has not provided a disclosure statement or has made financial performance representations in an unlawful manner, when the FTC Rule has been flouted flagrantly, or when widespread harm has been inflicted on the public. Isolated FTC Rule violations are generally ignored, as are technical violations such as violation of the FTC Rule’s waiting period before consummation of the franchise sale. The FTC has been more aggressive in prosecuting business opportunities sellers who do not comply with the FTC Rule.

When the FTC has taken on franchisors, it has been very aggressive in seeking relief. It has imposed pre-judgment freezes on the assets of the franchisor and its principal officers. It has also imposed hefty fines on some FTC Rule violators. As for minor or technical violations, the FTC has addressed this problem by implementing a program under which offenders may agree to participate in a remedial program rather than face prosecution. Under this program, the franchisor’s management must participate in programs designed to assure that the franchisor is aware of its responsibilities under the FTC Rule, and the FTC will indirectly monitor the franchisor’s sales activities for a

11 74 Fed. Reg. 857, 858 (Jan. 9, 2009).

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limited time, typically three years. All things considered, participation in this program is clearly a far more lenient and less expensive alternative than defending an action brought by the FTC, even when the franchisor is arguably in the right.

The absence of a right in an aggrieved franchisee to pursue a claim considerably reduces the risks of lawsuits resulting from FTC Rule violations. However, many states have adopted so-called “Baby FTC Acts” which, in essence, give franchisees causes of action for FTC Rule violations. Franchisees may also have state actions available for fraud or unfair or deceptive practices if the FTC Rule has been violated.

Q. What are the penalties for non-compliance under state registration laws?

The consequences for violations of state registration laws can also be dire. The remedies generally include civil penalties, including fines, provable damages, and injunctive relief. Criminal penalties, which may include fines or imprisonment, are also possible. State statutes grant franchisees the right to pursue their remedies by themselves, and in most states, grant franchisees the right to rescind their franchise purchases, even if they have suffered no provable damages. Some states have also adopted remedial programs that are similar to the FTC’s.

While the possibility of FTC enforcement has not been much of a deterrent, state enforcement is viewed with a higher level of fear by legitimate franchisors. Relatively speaking, most states have comparatively devoted more resources than the FTC to enforcing their acts, especially when the violation is the failure of the franchisor to register. However, when a franchisee claims that the franchisor has misrepresented what is being sold, the state may be more reluctant to bring its enforcement powers to bear, absent compelling evidence verifying the aggrieved franchisee’s position. Also, isolated technical violations of state law, if handled properly, generally do not bring about the state’s full wrath, absent clearly demonstrable damages resulting from the violation.

VI. Franchise Relationship Statutes

Q. Are there federal regulations regulating franchise relationships?

The federal government does not regulate franchise relationships generally. There are two exceptions to this statement—federal laws do regulate franchise relationships involving petroleum dealers and automobile dealers. The relationship between retailers and parties at higher levels in the petroleum distribution structure are regulated under the Petroleum Marketing Practices Act,12 which imposes restrictions on the termination, renewal, and transfer of petroleum franchises. The only federal statute governing the manufacturer-dealer relationship in the automotive industry is the Automobile Dealer Franchise Act,13 more commonly known as the “Automobile Dealer Day-In-Court Act.” The statute requires automobile manufacturers to deal in good faith—that is, to refrain from coercing or intimidating, and from threatening to coerce or intimidate. In practice, the Act has had little importance and has produced few judicial decisions.

12 15 U.S.C.A. §§ 2801–06 (West 1998 & Supp. 2008).13 15 U.S.C. §§ 1221–25 (2006).

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There are other federal laws—for example, the antitrust laws and the Racketeer Influenced and Corrupt Organizations Act (known as “RICO”)—that can affect franchise relationships. However, these statutes are not aimed specifically at the franchise arena, but instead at general commercial practices.

Q. Are there state laws regulating franchise relationships?

In contrast to the federal government, 18 states have regulations governing franchise relationships generally. These states include Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, Rhode Island, Virginia, Washington, and Wisconsin. Puerto Rico and the Virgin Islands also have franchise relationship laws. In addition, there are many state statutes regulating franchise relationships in specific industries such as beer, wine, and farm and heavy construction equipment.

Q. What do franchise relationship laws cover?

While there has been a considerable effort to standardize, from state to state, regulation of the franchise sales process, there is no well discerned pattern of state franchise relationship regulations. Aspects of the franchise relationship that may be covered by these statutes include terminations, renewals, transfers, encroachment, freedom of association, and purchasing restrictions, but no two statutes are substantially identical, except Rhode Island’s and Wisconsin’s. Most of them focus on only one, two, or three of these areas, and in many instances the regulatory approach among the states is dramatically different. The result is a very complicated regulatory scheme.

This disparity among the states begins with the fundamental issue of how franchises are defined. Typically, the definition of “franchise” is similar to the definition of “franchise” under the FTC Rule and include three elements. Virtually all of the statutes provide that the relationship must include the use of a trademark, logo, commercial symbol or the like, and that the franchisor must charge the franchisee a fee in order for a franchise to exist. It is the third prong of the definition where the statutes diverge. In some states, there must be a “community of interest” between the franchisor and the franchisee; in others, the franchisor must prescribe or suggest to the franchisee a “marketing plan.” Not all states—New Jersey and Wisconsin, for example—require all three elements to be present in order for the relationship to be subject to the statute. New Jersey, for example, has no fee requirement.

Q. How are franchisee terminations regulated under state laws?

Most franchise relationship statutes require a franchisor to have “good cause” before terminating a franchisee. “Good cause” is usually defined to include the failure of a franchisee to adhere to the provisions of the franchise agreement. In addition, most statutes require the franchisor to give the franchisee notice of a breach or default and an opportunity to cure. This notice requirement is generally not applicable to certain types of defaults such as bankruptcy, insolvency, or abandonment.

Today, in practice, these statutes usually have little effect on the termination process, for it is more common than not for the franchise agreement to contain provisions that substantially parallel these statutory requirements. Thus, even if the termination provisions of the relationship statutes

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were repealed, practice in the industry would remain largely unaffected. Most franchisors follow these termination procedures in large measure even in states where terminations have remained unregulated. This is probably due to a desire to maintain uniformity in the administration of the franchise system as well as the fact that courts in many jurisdictions have a predilection to prevent forfeitures, absent compelling circumstances, even though freedom of contract is the general rule in the United States’ judicial system.

Q. How are franchise renewals regulated under state laws?

In franchising, mandatory renewal rights are typically granted to franchisees, but there are some very well-known chains (McDonald’s, for example) in which renewals are granted only at the franchisor’s discretion. Some franchise relationship statutes have been designed to deal with these situations. In some states, such as Wisconsin, non-renewals are not permitted absent good cause. This, in effect, may require a franchisor to continue a relation beyond the bargained-for period. Other states, such as Missouri, simply impose procedural requirements upon the franchisor (e.g., 180 days advance notice of a decision not to renew). A third group of statutes imposes various burdens on the franchisor if it elects not to renew. For example, the franchisor may have to compensate the franchisee under Washington law, and in Iowa, the franchisor must agree not to enforce the post-term noncompetition provision of the franchise agreement.

Q. How are franchise transfers regulated under state laws?

Most franchise agreements permit transfers, but vest varying degrees of control in the franchisor over such transactions. The most stringent agreements provide that transfers may only be made with the franchisor’s consent, and such consent may be arbitrarily withheld. Other agreements simply state that consent may not be unreasonably withheld. It is also quite common for the franchise agreement to delineate some of the reasons which would permit the franchisor to deny transfers. These may include financial or technical inability, poor character, or existing interests in competing businesses. It is also common for the franchisor to impose varying conditions upon the transfer. These may include execution of a new form of franchise agreement, payment of a transfer fee (which may be substantial), execution of a general release by the transferor in favor of the franchisor, and completion of requisite training.

Generally, statutes regulating transfers require the franchisor to have good cause for withholding consent. Some statutes also require the franchisor to approve a transfer if the transferee meets the criteria for new franchisees. Other states have flip-flopped the approach and require the franchisee to notify the franchisor of the proposed transfer and to furnish it with specified types of information; the franchisor is then required to respond to the request within a specified period. And finally, in at least one state—California—the statute protects the rights of a deceased franchisee’s heirs to take over the business.

Q. Do the franchise statutes protect a franchisee’s freedom of association?

Ten states (Arkansas, California, Hawaii, Illinois, Iowa, Michigan, Minnesota, Nebraska, New Jersey, and Washington) have adopted provisions limiting the franchisor’s right to intervene in

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collective conduct by franchisees. Freedom of association statutes tend to take one of two forms. They prohibit a franchisor from either (1) restricting or inhibiting the rights of franchisees to join an association, or (2) prohibiting, directly or indirectly, the right of association among franchisees for any lawful purpose. Interestingly, there have been few cases to date that discuss any of these statutes. The leading precedent is 30 years old. That decision—McAlpine v. AAMCO Automatic Transmissions, Inc.—suggests that freedom of association is a constitutionally protected right of franchisees, which in turn might suggest that state regulation in this area may be unnecessary—a contention to which franchisee advocates would certainly object.14

Q. Are there limitations on a franchisor’s ability to encroach on a franchisee’s territory?

From a regulatory standpoint, the states have been notably silent on the encroachment issue where a franchisor has infringed upon his franchisee’s arguably exclusive territorial or customer rights. Only four states—Hawaii, Indiana, Minnesota and Washington—have statutes or regulations prohibiting encroachment. Iowa hampers, but does not prohibit, encroachment. Numerous court decisions, however, have addressed franchisee claims of encroachment.

VII. Conclusion

For the company planning to enter into distribution or licensing arrangements in the United States, care must be taken to consider the applicability of federal and state franchise and business opportunities laws and regulations. Compliance is not difficult to achieve, but it requires management of time and financial resources, as well as close association with competent counsel familiar not only with the published statutes and regulations, but with the unwritten “folklore” of franchising, the registration process, and, in some instances, the state administrators themselves. Once a franchise system is up and running, franchisors must be cognizant of state regulations which impair a franchisor’s freedom of contract. Designed to remedy early abuses in franchise relationships, these statutes result in franchisors being handcuffed in certain respects in the manners in which they deal with franchisees, such as terminations, non-renewals, transfers, and freedom of association. While the regulatory framework can be cumbersome, given that franchising has continued to flourish, it appears that a proper balance has been struck between the needs of franchisees for protection against power-hungry franchisors and the need for franchisors to be able to practice the entrepreneurial skills that have made them successful.

14 461 F. Supp. 1232, 1273–74 (E.D. Mich. 1978).

KILPATRICK STOCKTON

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

TRADEMARK & COPYRIGHT

Internet Branding

Judith A. Powell, Georges Nahitchevansky, James A. Trigg, Charles H. Hooker III, and Allison M. Scott

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Internet BrandingJudith A. Powell, Georges Nahitchevansky, James A. Trigg, Charles H. Hooker III, and Allison M. Scott

I. Introduction

“It is not easy to build brands in today’s environment. The brand builder who attempts to develop a strong brand is like a golfer playing on a course with heavy roughs, deep sandtraps, sharp doglegs, and vast water barriers. It is difficult to score well in such conditions.”1 Beyond the inherent difficulties of brand-building such as creating a coherent brand strategy, competing on price, and the need to invest resources in the core business, the ever-increasing role of the Internet brings additional hurdles.

This article addresses areas of difficulty and contention in branding on the Internet. Beginning with earlier consequences of Internet marketing, including the creation of the Internet Corporation for Assigned Names and Numbers (“ICANN”) and the Anticybersquatting Consumer Protection Act (“ACPA”), to more recent developments, such as pop-up and keyword advertising, screenscraping, contributory infringement, and virtual worlds, this article sets forth the jurisprudence surrounding disputes occurring along each of these frontiers. In part because the law in each of these areas has been built upon principles developed in an immediately preceding area, and in part because the technological advances in one area rely on those that came before, these developments are treated in rough chronological order. Throughout, the law on Internet branding continues to develop and, even along the most heavily litigated fronts, remains somewhat unsettled relative to other areas of intellectual property law.

A. ICANN Dispute Resolution and the Anticybersquatting Consumer Protection Act

The rise of the Internet in the 1990s brought with it a new challenge to brand owners—cybersquatting. In its most typical form, cybersquatting has involved the registration of domain names incorporating well-known trademarks and brand names, with the hope of selling them to the rightful owner at exorbitant prices. Until 1999, brand owners’ options were limited in pursuing such domain-name pirates. Most often, they were forced to litigate using the relatively ill-fitting doctrines of trademark infringement and dilution. Although courts generally were sympathetic to brand-owner plaintiffs in such actions, existing trademark law generally was not well-equipped to combat cybersquatting.2 In response, ICANN established a dispute resolution policy that virtually all domain registrars have since adopted,3 and Congress passed the ACPA.4

Thus, in addition to the earlier established doctrines of infringement, unfair competition, and dilution, trademark owners today routinely employ two further regimes to counteract cybersquatting

1 DaviD a. aaker, BuilDing Strong BranDS 26 (1996).2 See, e.g., Christopher R. Perry, Trademarks as Commodities: The “Famous” Roadblock to Applying Trademark Dilution in Cyberspace,

32 Conn. l. rev. 1127 (2000). 3 See ICANN, Uniform Domain Name Dispute Resolution Policy, available at http://www.icann.org/en/dndr/udrp.htm (“UDRP”) (“All

registrars in the .biz, .com, .info, .name, .net, and .org top-level domains follow the Uniform Domain-Name Dispute-Resolution Policy.”) (last visited Feb. 25, 2009).

4 15 U.S.C. § 1125(d) (2006).

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and its potentially deleterious effect on their brands. Both ICANN dispute resolution and the ACPA have their own advantages and limitations, which have been extensively detailed and discussed elsewhere.5 What follows briefly summarizes the current state of the law with respect to each mechanism, highlighting, where possible, further resources for the interested reader.

1. ICANN Dispute Resolution Services

ICANN is a non-profit, private-sector corporation created in 1998 by the U.S. Department of Commerce to preserve the operational stability of the Internet. It specifically coordinates the assignment of domain names, IP address numbers, protocol parameters, and port numbers.

To address cybersquatting, ICANN promulgated a Uniform Domain Name Dispute Resolution Policy (“UDRP”)6 and the Rules for Uniform Domain Name Dispute Resolution Policy (“Rules”).7 ICANN approves dispute-resolution service providers (“DRSP”) who conduct the administrative proceedings involving domain name disputes. These service providers are bound to conduct the administrative proceedings in accordance with the UDRP and the Rules.

The UDRP operates between the registrars and the holder of the domain name registration; all holders of domain name registrations take these names subject to the terms of the UDRP.8 The UDRP requires all holders to submit to a mandatory administrative proceeding if a third party complainant asserts that the domain name was wrongfully obtained. To prevail in the action, the complainant must establish: (a) identical or confusing similarity; (b) the respondent has no legitimate interests in the domain name at issue; and (c) the respondent registered and is using the domain name in bad faith.9

a) Identical or Confusing Similarity

To have a domain name transferred pursuant to ICANN’s UDRP, a complainant first must show that the respondent’s domain name is “identical or confusingly similar” to the complainant’s trademark or service mark.10 The UDRP does not require the complainant to have a registered mark. Moreover, although the UDRP specifically mentions trademarks and service marks, and not other intangible rights, some panel decisions have effectively allowed publicity rights to be asserted.11

5 See, e.g., Elizabeth M. Flanagan, No Free Parking: Obtaining Relief from Trademark-Infringing Domain Name Parking, 98 traDemark rep. 1160 (2008); Alyson B. Danowski, Defending Your Client’s Domain Name, 14 intell. prop. StrategiSt 3 (Sept. 2008).

6 ICANN UDRP, supra note 3.7 ICANN, Rules for Uniform Domain Name Dispute Resolution Policy (Oct. 24, 1999), http.//www.icann.org/dndr/udrp/uniform-rules.htm

(“ICANN Rules”).8 The UDRP states that by applying for a domain name registration, the applicant represents that, to the best of the applicant’s knowledge, its

domain name does not “infringe upon or otherwise violate the rights of any third party.” The UDRP further states the three circumstances when the registrar will cancel or transfer a domain name registration: (1) if the owner consents; (2) if a court orders such a transfer; or (3) if an administrative panel of an approved DRSP decides such a transfer is warranted. See id. ¶ 3.

9 Id. 10 Id. ¶ 4 (a)(i).11 See Scarlett Johansson v. Tristan Dare, WIPO Case No. D2008-1650 (Dec. 16, 2008) (granting transfer of scarlettjohansson.com); Nick

Cannon v. Modern Limited – Cayman Web Development, WIPO Case No. D2005-0575 (Aug. 23, 2005) (granting transfer of nickcannon.com); Kidman v. Zuccarini, WIPO Case No. D2000-1415 (Jan. 23, 2001) (granting transfer of nicolekidman.com and nicolekidmannude.com); Julia Fiona Roberts v. Russell Boyd, WIPO Case No. D2000-210 (May 29, 2000) (granting transfer of juliaroberts.com). In many of these cases, the panel found that the complainant’s name functioned as a “common law” mark. WIPO case decisions are available at http://www.wipo.int/amc/en/domains/search.

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Because most published opinions have involved very similar names, the “identical or confusingly similar” element has not generated much controversy. In Gateway, Inc. v. James Cadieux, for example, the respondent registered <pcgateway.com> and <pcgateway.net>, which were found confusingly similar to complainant’s registered marks.12 In determining confusing similarity, the DRSP panel typically does not analyze the traditional likelihood of confusion factors such as the similarity of goods and services or channels of trade.13 Rather, the marks are assessed alone, without market context.

On occasion, however, complainants fail to establish confusing similarity, especially when the complainant’s mark is weak or when the third-party uses of the mark are prevalent. For example, in Reed Publishing v. Select Gourmet Foods Inc., the panel found the respondent’s domain registration for <whoiswhoinlaw.com> and <whoiswhoinpolitics.com> not confusingly similar to complainant’s WHO’S WHO IN AMERICAN LAW and WHO’S WHO IN AMERICAN POLITICS trademarks.14 Among other reasons, respondent successfully demonstrated numerous third-party uses of the “who’s who” motif without geographical limitations.

b) Respondent Has no Legitimate Interest in the Domain Name

In addition to confusing similarity, the UDRP requires a complainant to establish that the respondent has “no rights or legitimate interests in respect of the domain name.”15 A complainant may discharge this burden by stating the reason “why [the respondent] should be considered as having no rights or legitimate interests” in the domain name.16 If the complainant has a federally registered trademark, nationwide constructive notice can be asserted to demonstrate the respondent’s lack of legitimate rights or interests in the domain name.17

If the complainant provides a credible reason why the respondent has no legitimate interests, the burden generally shifts to the respondent to demonstrate some legitimate interest. For example, in Nandos International Limited v. M Fareed Farukhi,18 the complainant stated that it filed a U.S. trademark application for the mark NANDO’S at least five years before the respondent registered the domain names <nando.com> and <nandoschicken.com>, but the respondent failed to submit evidence of interest in the name. Accordingly, the panel concluded the respondent lacked a legitimate interest in the domain name.19

12 WIPO Case No. D2000-0198 (May 25, 2000).13 See, e.g., Fed. Cartridge Co. v. Madmouse Commc’ns, WIPO Case No. D2001–0756 (July 24, 2001).14 CPR File No. CPR004 (Aug. 29, 2000).15 See ICANN UDRP, supra note 3, ¶ 4(a)(ii). 16 See ICANN Rules, supra note 7, ¶ 3(b)(ix)(2). 17 See Cyberbingo Corp. v. 207 Media Inc., WIPO Case NO. D2005-0714 (Oct. 4, 2005) (“Actual or constructive knowledge of Complainant’s

CYBERBINGO trademark registration, prior to registration of the confusingly similar domain name in dispute, undermines any claim to legitimacy.”); Sunfest v. Elec. Sys. Tech., Inc., WIPO Case No. D2000-0631 (Oct. 3, 2000); J. Crew Int’l v. crew.com, WIPO Case No. D2000-0054 (Apr. 20, 2000).

18 WIPO Case No. D2000-0225 (May 23, 2000). See also Wal-Mart Stores, Inc. v. Walmarket Canada, WIPO Case No. D2000-0150 (May 2, 2000).

19 WIPO Case No. D2000-0225.

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In view of this shifting burden, the UDRP provides guidance to respondents seeking to demonstrate legitimacy by setting forth three indicia of legitimate interests.20 Establishing one of these indicia effectively will prevent a complainant from establishing the second prong—“lack of legitimate interests”—and allows a respondent to maintain it lacked bad faith (the third prong), discussed infra. The three indicia of legitimate interest in the domain name are:

(1) before any notice to [the holder] of the dispute, [the holder’s] use of, or demonstrable preparations to use, the domain name or a name corresponding to the domain name in connection with a bona fide offering of goods or services; or

(2) [the holder] (as an individual, business, or other organization) [has] been commonly known by the domain name, even if [the holder has] acquired no trademark or service mark rights; or

(3) [the holder is] making a legitimate noncommercial or fair use of the domain name, without intent for commercial gain to misleadingly divert consumers or to tarnish the trademark or service mark at issue.21

First, if the respondent can show it was selling goods bearing the mark before it knew of the dispute, then a legitimate right generally is established. Similarly, if the respondent has adopted a generic term describing the goods he sells, then a panel is more apt to find legitimate rights. For instance, in Eauto, LLC v. Triple S. Auto Parts, the respondent had been selling auto lamps and decided to market them on the web.22 The panel decided that “eautolamps” was an example of an Internet-based description of a generic product because “the letter ‘e’ preceding [a product] has come to be understood as an electronic, Internet-based form of the same.”23 Thus the panel held for the respondent. However, merely using the domain name to link to other sites does not constitute a bona fide offering of goods or services.24

The second indicator of a “legitimate interest” provides protection to respondents who register domains for their commonly known names, even if they have not acquired trademark rights in the names.25 This clause protects a company that does not use its name in conjunction with goods or services, but nevertheless registers the company name as part of a domain name. An effort to register a common name in such circumstances negates the intent to pirate the rights of others, which is the narrow target of the ICANN system.26

20 See ICANN UDRP, supra note 3, ¶ 4(c).21 See id.22 WIPO Case No. D2000-0047 (Mar. 24, 2000). 23 Id. at 5. 24 See Pardes Inst. of Jewish Studies v. Hans Schultz LLC, WIPO Case No. D2008-0648 (July 3, 2008) (citing cases); Sunfest, WIPO Case

No. D2000-0631; Easy Jet Airline Co. v. Steggles, WIPO Case No. D2000-0024 (Mar. 17, 2000).25 ICANN UDRP, supra note 3, ¶ 4 (c)(ii); see Ken’s Foods Inc. v. kens.com, WIPO Case No. D2005-0721 (Sept. 11, 2005) (refusing to

transfer kens.com, the domain name at which respondent, whose given name was “Ken,” operated a weblog).26 See ICANN, Domain Name Dispute Resolution Policies, http://www.icann.org/udrp/ (last visited Mar. 25, 2009) (describing the purpose

of the ICANN system as preventing “abusive” registrations).

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Third, the UDRP protects legitimate non-commercial or fair use of the domain name so long as customers are not diverted or trademark rights are not tarnished for commercial gain.27 This defense is commonly invoked, but is rarely successful, especially if the respondent sells goods in addition to criticizing the trademark owner. In Monty and Pat Roberts, Inc. v. Bill Keith,28 for example, the panel rejected respondent’s free-speech assertion, stating “[t]he fact that Respondent’s primary motive for establishing its site may be to criticize Complainant does not insulate Respondent from the fact that it is directly and indirectly offering products for sale . . . .”29

c) Bad Faith

Even if a complainant shows that the respondent holds a domain name that is confusingly similar to the complainant’s trademark and that the respondent has no legitimate rights or interests in the mark, the complainant still must establish that the respondent has registered and is using the domain name in “bad faith.”30

The “use” requirement has caused concern for complainants because the UDRP does not clearly define this term and many cybersquatters do not actively use the domain names they have registered. In general, if the domain name registered by respondent has any display, or if the domain name owner makes any attempt to sell the name at a profit, then the use requirement probably will be met.31 Absent such activity, a panel may find the use requirement lacking.32 However, if the trademark at issue is particularly strong and well-known, a distinct possibility exists that a panelist will overlook the use requirement and order the transfer of the name.33

Assuming the use requirement is met, a complainant still must demonstrate respondent’s bad faith.34 The UDRP provides four specific circumstances that satisfy this element:

(i) circumstances indicating that [the holder has] registered or [has] acquired the domain name primarily for the purpose of selling, renting or otherwise transferring the domain name registration to the complainant who is the owner of the trademark or service mark or

27 See ICANN UDRP, supra note 3, ¶ 4 (c)(iii).28 WIPO Case No. D2000-0299 (June 9, 2000).29 Id. at 10. Compare Sermo, Inc. v. CatalystMD, LLC, WIPO Case No. D2008-0647 (July 2, 2008) (refusing to transfer domain name

because respondent had a legitimate interest in using the domain name sermosucks.com in connection with a criticism site which he operated without any intent for commercial gain).

30 ICANN UDRP, supra note 3, ¶ 4 (a)(iii).31 See, e.g., World Wrestling Fed’n, Inc. v. Bosman, WIPO Case No. D1999-0001 (Jan. 4, 2000) (holding that the offer to sell the domain

name registration to the complainant for a profit was a sufficient “use” of the domain name to satisfy the UDRP).32 See, e.g., Cyro Indus. v. Contemporary Design, WIPO Case No. D2000-0336 (June 19, 2000) (holding that because respondent never

posted a web site at the domain name <acrylite.com> and never contacted the complainant, it did not use the domain name as the UDRP requires); Sporoptic Pouilloux S.A. v. William H. Wilson, WIPO Case No. D2000-0265 (June 16, 2000) (refusing to transfer domain name because no evidence indicated respondent did anything other than register the domain name in bad faith).

33 Telstra Corp. Ltd. v. Nuclear Marshmallows, WIPO Case No. D2000-0003 (Feb. 18, 2000) (because the complainant’s trademark was strong and the respondent attempted to conceal its identity, the panel reasoned that respondent’s activities were inconsistent with a good faith use of the domain name); see also Société pour l’Oeuvre et la Mémoire d’Antoine de Saint Exupéry – Succession Saint Exupéry – D’Agay v. Perlegos Properties, WIPO Case No. D2005-1085 (Jan. 2, 2006) (transferring thelittleprince.com despite the fact that respondent was not making use of the website).

34 ICANN UDRP, supra note 3, ¶ 4 (a)(iii).

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to a competitor of that complainant, for valuable consideration in excess of [the holder’s] out-of-pocket costs directly related to the domain name; or

(ii) [the holder has] registered the domain name in order to prevent the owner of the trademark or service mark from reflecting the mark in a corresponding domain name, provided that [the holder has] engaged in a pattern of such conduct; or

(iii) [the holder has] registered the domain name primarily for the purpose of disrupting the business of a competitor; or

(iv) by using the domain name, [the holder has] intentionally attempted to attract, for commercial gain, Internet users to [its] website or other online location, by creating a likelihood of confusion with the complainant’s mark as to the source, sponsorship, affiliation, or endorsement of [the holder’s] website or location or of a product or service on [the holder’s] website or location.35

Numerous panel decisions explain and apply each of these bad faith indicia. They are briefly addressed here.

i) Primary Purpose to Sell the Name

Panels generally have adopted a rather low threshold for establishing a primary intent to sell the name to a trademark owner or a competitor. This is likely due in part to the reality that if the complainant has shown that the domain name is confusingly similar to its trademark, and that the respondent has no legitimate interests in the name, then “bad faith” can be inferred. For example, in Home Interiors & Gifts, Inc. v. Home Interiors, the panel found that the posting of a counter displaying web page hits at the websites <homeinteriors.net> and <homeinteriorsandgifts.com> was enough to show an intent to sell, because the counter illustrated the number of diverted web users, and thus supported the cybersquatter’s price.36 Likewise, Educational Testing Service v. TOEFL concluded that proof of a general intent to sell the website <toefl.com> to any buyer, as contrasted with an intent to sell the domain name to the trademark owner or its competitor, was sufficient to show bad faith.37

ii) Pattern of Bad Faith Registration

A pattern of infringing registrations also supports a finding of bad faith.38 This indicator is aimed at the stereotypical cybersquatter who has registered numerous domain names incorporating well-known trademarks. While an obvious cybersquatter may have hundreds of registrations, the more difficult question arises when a respondent has registered only a few suspect domain names. Panels have been inconsistent concerning how many suspicious registrations are sufficient to constitute bad

35 Id. ¶ (4)(b). The UDRP sets forth the elements out in second person, addressing the registrants of domain names more directly in an apparent effort to give clear notice that their registrations are subject to the terms of the UDRP.

36 WIPO Case No. D2000-0010 (Mar. 7, 2000). 37 WIPO Case No. D2000-0044 (Mar. 16, 2000). 38 ICANN UDRP, supra note 3, ¶ 4(b)(ii).

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faith: one case found two or three insufficient;39 another found three to be enough.40 While no magic number exists, if a respondent has substantially more than three dubious registrations, a pattern is likely to be found, especially if the registrations contain well-known trademarks.

iii) Registration Primarily to Disrupt a Competitor’s Business

Panels have had little difficulty finding bad faith when a respondent has registered a mark primarily to deny a competitor use of a mark on the Internet.41 In Georgia Gulf Corp. v. The Ross Group, for instance, respondent had registered domain names nearly identical to its competitors’ trade names.42 The respondent’s website simply displayed a notice that the registered site had been reserved and gave contact information.43 After being served with a complaint, the respondent e-mailed the complainant and offered to sell the site for $36,000.44 The panel concluded that respondent “registered the domain name to prevent complainant from reflecting the mark in a corresponding domain name and . . . primarily for the purpose of disrupting the business of a competitor.”45

iv) Creating Confusion for Commercial Gain

Finally, bad faith generally will be found when a respondent creates confusion between the domain name and another’s trademark to attract users to its website. For example, in British Broadcasting Corp. v. Renteria, the respondent, an individual in Caracas, Venezuela, registered the domain names <bbcdelondres.com>, <bbcenespanol.com>, <bbcenespanol.net>, and <bbcenespanol.org>.46 At one of these sites, the respondent used the BBC’s logo, framed the content of its website, and described itself as being a “world leader in news” offering “up to date, accurate and independent information 24 hours a day.”47 The panel concluded such conduct constituted an intentional attempt to lure web users for commercial gain by creating confusion as to source, sponsorship, or affiliation.48

In sum, under the ICANN UDRP, domain names are transferred when the domain name is identical or confusingly similar to another’s trademark or service mark, the domain-name registrant has no legitimate interests in the domain, and the registrant acted in bad faith. Good faith domain name registrations that result in likelihood of confusion or trademark dilution should not be transferred in an ICANN proceeding. In this way, the ICANN dispute resolution system is not an alternative vehicle for vindicating trademark rights. In practice, much turns on what kind of proof is available to establish “bad faith.” Because no effective discovery mechanism exists, a complainant often

39 Ingersoll-Rand Co. v. Gully, WIPO Case No. D2000-0021 (Mar. 9, 2000). But see Vitro S.A. de C.V., v. ICG, WIPO Case No. D2005-1150 (Dec. 26, 2005) (stating that while generally, two dubious registrations was insufficient to show a pattern for bad faith purposes, such a strict conception was not required where respondent was complainant’s former employee and the two domain names he registered were the two most obvious domain names for complainant).

40 Bellevue Square Managers, WIPO Case No. D2000-0056.41 ICANN UDRP, supra note 3, ¶ 4(b)(iii).42 WIPO Case No. D2000-0218 (June 14, 2000).43 Id.44 Id.45 Id. at 3. 46 WIPO Case No. D2000-0050 (Mar. 23, 2000). 47 Id. at 4. 48 Id. at 6.

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will have to demonstrate bad faith with publicly available information or proof of extortionary communications made by the respondent.

Finally, participants in ICANN proceedings should know that an ICANN decision is not the “final word.” Participants dissatisfied with an ICANN result can suspend the transfer of a contested domain name by filing a federal district court action and providing notice to the domain name registrar within ten days of the adverse ICANN ruling.49 Thus, the only real effect of an ICANN proceeding is to transfer possession of a domain name, as participants’ legal rights are not affected by the outcome. Few bad faith cybersquatters, however, will likely file a lawsuit to recapture registrations due to the scrutiny they are likely to be subjected to and the prohibitive costs of litigation.

2. The Anticybersquatting Consumer Protection Act

For brand owners seeking greater legal force than is available under the ICANN UDRP for ill-gotten domain names that threaten a strong mark or brand, the ACPA was enacted in 1999 as an addition to the Lanham Act.50 Like other Lanham Act claims, a plaintiff may seek injunctive relief, an accounting of defendant’s profits, actual damages, costs, and attorneys’ fees.51 In the alternative, the ACPA provides that a “plaintiff may elect, at any time before final judgment is rendered by the trial court, to recover, instead of actual damages and profits, an award of statutory damages in the amount of not less than $1,000 and not more than $100,000 per domain name, as the court considers just.”52 The availability of statutory damages can be used to incentivize settlement or to envision summary judgment as a plaintiff’s end-game.

To prevail on the merits under the ACPA, the plaintiff must show that: (1) its mark is distinctive or famous; (2) the defendant’s domain name is “identical or confusingly similar” to plaintiff’s mark, or dilutive of its famous mark; and (3) the defendant acted with a bad faith intent to profit from plaintiff’s mark.53 One difference between these elements and the elements under the ICANN UDRP is that the ACPA prohibits domain names that are “dilutive” of a famous mark. The term “dilutive” broadens the field of potentially infringing domain names to include not only confusingly similar names, but also those that weaken the selling power of the famous mark.54 At least one appellate court specifically has adopted the criteria for determining fame set forth in the Federal Trademark Dilution Act.55

The protection against trademark dilution in this context may encompass “[trademark] sucks” registrations, which have not consistently been deemed confusingly similar. In Lucent Technologies,

49 See ICANN UDRP, supra note 3, ¶ 4(k) (“If an Administrative Panel decides that [respondent] domain name registration should be canceled or transferred, we will wait ten (10) business days (as observed in the location of our principal office) after we are informed by the applicable Provider of the Administrative Panel’s decision before implementing that decision.”).

50 See 15 U.S.C. § 1125(d) (2006).51 See Id. §§ 1114, 1116–1117 (2006).52 Id. at § 1117.53 See Sporty’s Farm L.L.C. v. Sportsman’s Market, Inc., 202 F.3d 489, 497 (2d Cir. 2000); Globalsantafe Corp. v. Globalsantafe.com, 250

F. Supp. 2d 610, 616 (E.D. Vir. 2003). 54 Compare with ICANN UDRP, supra note 3, ¶ 4(a)(i) (noting that the standard is “identical or confusingly similar to a trademark or service

mark in which the complainant has rights”). 55 Sporty’s Farm, 202 F.3d at 497.

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Inc. v. Johnson, the plaintiff stated a claim under the ACPA where the defendant’s <lucentsucks.com> domain allegedly displayed pornography.56 The court determined that such an association could “corrode[] the positive associations of the plaintiff’s mark, thereby reducing the mark’s value,” which is actionable under a dilution theory.57

Another facial difference between the ACPA and the ICANN UDRP is the former’s explicit inclusion of rights of publicity.58 The statute includes an individual’s name, whereas the UDRP only includes trademarks and service marks.59 While several ICANN decisions have transferred domain names based on rights of publicity, a panel could read the language of the UDRP more narrowly.

Like the ICANN dispute resolution system, the central issue under the ACPA is the defendant’s bad faith. The ACPA sets forth a list of factors the courts may consider in determining whether a registration is actionable:

(1) the trademark or other intellectual property rights of the person, if any, in the domain name;

(2) the extent to which the domain name consists of the legal name of the person or a name that is otherwise commonly used to identify that person;

(3) the person’s prior use, if any, of the domain name in connection with the bona fide of-fering of any goods or services;

(4) the person’s bona fide noncommercial or fair use of the mark in a site accessible under the domain name;

(5) the person’s intent to divert consumers from the mark owner’s online location to a site accessible under the domain name that could harm the goodwill represented by the mark, either for commercial gain or with the intent to tarnish or disparage the mark, by creating a likelihood of confusion as to the source, sponsorship, affiliation, or endorse-ment of the site;

(6) the person’s offer to transfer, sell, or otherwise assign the domain name to the mark owner or any third party for financial gain without having used, or having an intent to use, the domain name in the bona fide offering of any goods or services, or the person’s prior conduct, indicating a pattern of such conduct;

(7) the person’s provision of material and misleading false contact information when ap-plying for the registration of the domain name, the person’s intentional failure to main-tain accurate contact information, or the person’s prior conduct indicating a pattern of such conduct;

(8) the person’s registration or acquisition of multiple domain names which the person knows are identical or confusingly similar to marks of others that are distinctive at the time of registration of such domain names, or dilutive of famous marks of others

56 56 U.S.P.Q. 2d 1637 (C.D. Cal. 2000). But see Lucent Techs., Inc. v. Lucentsucks.com, 95 F. Supp. 2d 528, 535 (E.D. Va. 2000) (suggesting that use of “sucks” in domain name would not, in and of itself, be actionable).

57 Lucent Tech., Inc. v. Johnson, 57 U.S.P.Q.2d at 1639. 58 15 U.S.C. § 1125(d)(1)(A) (2000) (“[A] person shall be liable in a civil action by the owner of a mark, including a personal name which

is protected as a mark under this section”).59 ICANN UDRP, supra note 3, ¶ 4(a)(i) (stating that respondent’s “domain name is identical or confusingly similar to a trademark or

service mark in which the complainant has rights”) (emphasis added).

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that are famous at the time of registration of such domain names, without regard to the goods or services of the parties; and

(9) the extent to which the mark incorporated in the person’s domain name registration is or is not distinctive and famous within the meaning of the [list of factors for determin-ing fame under § 43(c)(1) of the Lanham Act].60

While these factors are similar to the bad faith factors found in the ICANN system, two important differences exist. The most significant is the absence of any requirement that the domain name registrant actually use the domain name. As discussed above, the ICANN UDRP states that the complainant must show that the registration “has been registered and is being used in bad faith.”61 By contrast, the ACPA imposes liability on any person who “registers, traffics in, or uses a domain name” in bad faith.62 Because many cybersquatters register hundreds of names and never use them, the ACPA’s broad reach is a truly significant feature.

Courts generally apply the bad faith factors listed in the statute,63 but they also have considered other factors, as the ACPA clearly contemplates. In Sporty’s Farm L.L.C. v. Sportsman’s Market, Inc., for example, the court found bad faith even when the counterclaim defendant, owner of the <sportys.com> domain name, did not seek to sell the domain name back to the trademark owners.64 The court analyzed all nine factors, but was most moved by the “unique circumstances” of the case, which included evidence that the defendant’s parent corporation knew of the plaintiff’s SPORTY’S trademark for aviation goods and services at the time of registration, and was planning to go into direct competition with it in these markets.65 The court determined that the defendant registered “for the primary purpose of keeping Sportsman’s from using that domain name.”66

In Shields v. Zuccarini, the plaintiff operated a popular website at <www.joecartoon.com>, which featured plaintiff’s humorous animations.67 The defendant registered the domains <joescartoon.com>, <joecarton.com>, <joescartons.com>, and <cartoonjoe.com>, which featured advertisements for other sites and credit card companies.68 Visitors who accidentally misspelled the Joe Cartoon web address were “mousetrapped” in the defendant’s site, prevented from easily exiting by a succession of ads which came up on the screen.69

60 15 U.S.C. § 1125(d)(1)(B)(i) (2006). The ACPA further states: “Bad faith intent described under subparagraph (A) shall not be found in any case in which the court determines that the person believed and had reasonable grounds to believe that the use of the domain name was a fair use or otherwise lawful.” Id. § 1125(d)(1)(B)(ii). At lease one court of appeals has held that the usual preponderance of the evidence standard applies to claims of bad faith under this section of the Lanham Act. See Harrods Ltd. v. Sixty Internet Domain Names, 302 F.3d 214, 227 (4th Cir. 2002).

61 See ICANN UDRP, supra note 3, ¶ 4(a)(iii) (emphasis added). 62 15 U.S.C. § 1125(d)(1)(A)(ii) (2006) (emphasis added).63 See Northland Ins. Cos. v. Blaylock, 115 F. Supp. 2d 1108, 1124 n.8 (D. Minn. 2000).64 202 F.3d 489 (2d Cir. 2000).65 Id. at 499.66 Id. 67 89 F. Supp. 2d 634 (E.D. Pa. 2000), aff’d, 254 F.3d 476 (3d Cir. 2001). On appeal, the Third Circuit rejected defendants’ argument that

the ACPA was not meant to prevent intentional misspellings, also known as “typosquatting.” Id. at 483.68 Shields, 89 F. Supp 2d at 635.69 Id.

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The court easily concluded that the defendant registered with the required bad faith: he had no bona fide intellectual property rights to the name, the name was not his personal name, and he admitted in court that he registered thousands of names, and their misspellings, in an effort to divert Internet traffic to his sites.70 Ultimately, Shields awarded the plaintiff $50,000 in statutory damages ($10,000 per infringing domain name), attorneys’ fees of $35,798.50, and costs of $3,310.96.71

Shields illustrates well the advantages of pursuing cybersquatters under the ACPA, which makes available not only statutory damages (potentially providing a means of lower litigation costs) or profits and actual damages (providing for potentially larger damages amounts), but also attorneys’ fees and costs. Since professional cybersquatting defendants often have hundreds or thousands of illegitimate domain names, simply losing several of them in a court ordered transfer does not seriously affect their operations. Cases like Shields properly compensate plaintiffs and serve as a deterrent to future piracy.72 Thus, for plaintiffs willing to undertake the expense of litigation—as opposed to the generally less expensive alternative of dispute resolution under the ICANN UDRP—asserting claims pursuant to the ACPA may be the preferred means of establishing proper domain name ownership.

B. Pop-up Ads

Even after a brand owner thoroughly establishes its ownership of domain names associated with its trademarks, service marks, and trade names, branding on the Internet presents additional challenges, such as potential infringement or dilution from others’ uses of pop-up advertisements and search engine keyword terms. These new challenges owe their existence to the more interactive nature of branding on the Internet.

In contrast to the traditional advertising model, the Web is all about experiences. In the Web environment, the role of the audience is an active one; the lean-forward rather than the lean-back attitude changes everything. The audience member usually has a functional goal in mind—seeking information, entertainment, or transactions—and ignores or treats as an annoyance anything that gets in the way . . . .73

In many ways, pop-up advertising epitomizes both the “lean-forward” approach of Internet marketing and the potential disregard consumers show for annoying or superfluous information.74

70 Id. at 640.71 Shields v. Zuccarini, No. Civ.A. 00-494, 2000 WL 1053884 (E.D. Pa. July 18, 2000).72 Courts interpreting the ACPA have evidenced a willingness to impose significant statutory damages awards. In Electric Boutique Holdings

Corp. v. Zuccarini, 56 U.S.P.Q.2d 1705 (E.D. Pa. 2000), aff’d, 33 F. App’x 647 (3d Cir. 2002), the court awarded the plaintiff $500,000 in statutory damages, $100,000 for each of the five infringing domain names registered by defendant Zuccarini. See also Pinehurst, Inc. v. Wick, 256 F. Supp. 2d 424 (M.D.N.C. 2003) (awarding trademark holder $100,000 in statutory damages).

73 DaviD a. aaker & eriCh JoaChimSthaler, BranD leaDerShip 233 (1999).74 “A ‘pop-up’ ad appears on a computer screen to obscure and cover most of the information on the screen.” 4 J. thomaS mCCarthy,

mCCarthy on traDemarkS anD unfair Competition § 25:70.75 (4th ed. 2009). Using similar technology, but generally causing slightly less irritation, a “pop-under” ad “opens a new browser window hidden under the active window.” See http://en.wikipedia.org/wiki/Pop-up_advertising (last visited on Mar. 26, 2009).

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By “popping-up” in response to consumers’ own Internet searches,75 pop-up ads have provided advertisers with the ability to target and engage potential customers based on consumers’ own behavior. The irritation often caused by pop-up ads, however, has given rise to a veritable cottage industry aimed at suppressing this medium.

Pop-ups became popular after the original form of Internet advertising, the banner ad, proved less effective than advertisers had hoped.76 In particular, the “click through rate” of banners caused many advertisers to believe that the Internet would never become a viable marketing medium. As a result, Internet advertising revenues began to diminish until around 2002, when pop-up ads began to become extremely popular. From that time until 2004, when Microsoft released Service Pack 2 for Windows XP—aimed at suppressing most pop-ups—pop-up advertising enjoyed what may have been its zenith.77

Around the time pop-up advertising began encountering technological obstacles, it started facing new legal challenges as well. In 2003, several companies brought suit against a pop-up advertiser, WhenU.com, Inc.78 The trademark infringement claims asserted in these lawsuits alleged that the pop-up ads disseminated by WhenU.com confused Internet users into believing that the pop-up ads were approved by, or associated with, the website triggering the pop-up ad.79

The district courts for the Eastern District of Virginia and Eastern District of Michigan held that WhenU.com had not violated the Lanham Act because it had not “used” the respective plaintiffs’ trademarks within the Act’s definition of “use in commerce.”80 U-Haul’s claims against WhenU.com in Virginia were dismissed on summary judgment because “(1) WhenU’s pop-up window is separate and distinct from U-Haul’s Web site, (2) WhenU does not advertise or promote U-Haul’s trademarks . . . , and (3) [WhenU’s] SaveNow program does not hinder or impede Internet users from accessing U-Haul’s Web site in such a manner that WhenU ‘uses’ U-Haul’s trademarks.”81 Similarly, the Eastern District of Michigan refused to grant Wells Fargo the preliminary injunction it sought against WhenU.com because Wells Fargo’s “marks are neither displayed or appear to be displayed on WhenU’s windows, and the fact that WhenU advertisements appear on a computer

75 Pop-up ad programs take different forms but often are “bundled” with other free software programs and saved onto a consumer’s computer when the consumer downloads the other free software, such as a free screensaver program. Once downloaded, the pop-ad program “scan[s] the user’s Internet activity . . . . to deliver[] pop-up ads matched to the user’s perceived interests.” mCCarthy, supra note 74, § 25:70.75.

76 See http://en.wikipedia.org/wiki/Pop-up_advertising (last visited on Mar. 26, 2009).77 “Advertisers continually seek ways to circumvent such restrictions. For example, some pop-up ads are generated using Adobe Flash. Since

pop-up blockers only blocked the JavaScript method, the Flash method would bypass the pop-up blocker.” Id. 78 mCCarthy, supra note 74, § 25:70.75 (citing U-Haul Int’l, Inc. v. WhenU.com, Inc., 279 F. Supp. 2d 723 (E.D. Va. 2003); 1-800 Contacts,

Inc. v. WhenU.com, Inc., 309 F. Supp. 2d 467 (S.D.N.Y. 2003); and Wells Fargo & Co. v. WhenU.com, Inc., 293 F. Supp. 2d 734 (E.D. Mich. 2003)).

79 Id. 80 Section 45 of the Lanham Act defines “use in commerce” with respect to goods, inter alia, as “plac[ing] in any manner [a mark] on the

goods or their containers or the displays associated therewith or . . . on documents associated with the goods or their sale; it defines “use in commerce” with respect to services as “us[ing] or display[ing the mark] in the sale or advertising of services and the services are rendered in commerce . . . .” 15 U.S.C. § 1127 (2006).

81 U-Haul Int’l, Inc., 279 F. Supp. 2d at 729.

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screen at the same time [that Wells Fargo’s] web pages are visible in a separate window does not constitute a use in commerce of [Wells Fargo’s] mark.82”

Contrary to these decisions, the District Court for the Southern District of New York granted 1-800 Contacts a preliminary injunction against WhenU.com for WhenU’s pop-up ads for Vision Direct, which appeared when an Internet user accessed 1-800 Contacts’ website.83 Because WhenU caused Vision Direct’s pop-up ad to appear when a person entered 1-800 Contacts’ URL, the court found that WhenU “used in commerce” 1-800 Contacts’ trademark to cause both initial-interest and actual confusion.84 Accordingly, the court preliminarily barred WhenU from using 1-800 Contacts’ web address in the SaveNow program that triggered the Vision Direct pop-up ads.85

The Second Circuit, however, reversed.86 Focusing on “[t]he fact . . . that WhenU does not reproduce or display 1-800’s trademarks at all . . . [or] cause the trademarks to be displayed to a [computer]-user,” the Second Circuit found that the “fatal flaw with [the district court’s] holding is that WhenU’s pop-up ads do not display the 1-800 trademark” and thus cannot constitute a “use in commerce.”87 Expounding on the absence of “display,” the court opined:

A company’s internal utilization of a trademark in a way that does not communicate it to the public is analogous to an individual’s private thoughts about a trademark. Such conduct simply does not violate the Lanham Act, which is concerned with the use of trademarks in connection with the sale of goods or services in a manner likely to lead to consumer confusion as to the source of such goods or services.88

Because WhenU merely used 1-800 Contacts’ website—not its trademark—in WhenU’s SaveNow directory, which was not visible to the public or consumers, to trigger advertisements which popped up in a separate window that was prominently branded with WhenU’s and Vision Direct’s own trademarks, the Second Circuit held that no “use in commerce” occurred.89 From a practical standpoint, the Second Circuit found it “noteworthy” that before filing this lawsuit, 1-800 Contacts “entered into agreements with WhenU competitors Gator and Yahoo! to have its own pop-up and banner ads delivered to [computer]-users in response to the [computer]-user’s input of particular website addresses and keywords that were specified by 1-800.”90 The court harkened back to traditional marketing principles, whereby vendors routinely “seek specific ‘product placement’ in retail stores precisely to capitalize on their competitors’ name recognition”—such as a drug store

82 Wells Fargo & Co., 293 F. Supp. 2d 761.83 1-800 Contacts, Inc., 309 F. Supp. 2d at 480. 84 As an additional basis for finding “use in commerce,” the district court concluded that WhenU’s inclusion of Plaintiff’s Web site

<www.1800contacts.com>, which incorporates the 1-800 CONTACTS trademark, “in the proprietary WhenU.com directory of terms that triggers pop-up advertisements on SaveNow users’ computers . . . WhenU.com ‘uses’ Plaintiff’s mark . . . to advertise and publicize companies that are in direct competition with Plaintiff.” Id. at 489.

85 Id. 86 See 1-800 Contacts, Inc. v. WhenU.com, Inc., 414 F.3d 400 (2d Cir. 2005).87 Id. at 408–10 (emphasis in original).88 Id. at 409.89 Id. at 410 (“In addition, 1-800’s website address is not the only term in the SaveNow directory that could trigger a Vision Direct ad to

‘pop up’ . . . . For example, an ad could be triggered if a [computer]-user[] searched for ‘contacts’ or ‘eye care,’ both terms contained in the directory, and then clicked on the listed hyperlink to 1-800’s website.”).

90 Id. at 409 n.12.

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placing “its own store-brand generic products next to the trademarked products they emulate in order to induce a customer who has specifically sought out the trademarked product to consider the store’s less expensive alternative.”91

Thus, a consensus appears to have emerged among courts that, as long as pop-up ads appear in a separate window and do not use another’s trademark in the advertisement itself, they generally do not violate the Lanham Act. This reasoning, developed in the pop-up advertising context, has held considerable sway over the outcome of keyword-advertising cases, which are considered next.

C. Keyword Advertising

Like pop-up ads, “keyword advertising” typifies the interactive contemporary approach to Internet branding. By actively anticipating the content of consumers’ searches, keyword advertising allows a brand owner to purchase commonly used search terms, or “keywords,” from an Internet search engine like Google, so that an advertisement and link to the company’s website appears as a “sponsored link” anytime consumers enter a search incorporating the keyword.92 For instance, using Google’s “AdWords” program, “an advertiser can bid on terms (keywords) an Internet user might enter as a search term on Google.”93 Google then links the purchased keyword terms with the advertiser’s sponsored link or advertisement. “When an Internet user enters the keyword, it triggers the sponsored link to appear on the search results page either to the right or immediately above the search results.”94 In tandem with this program, Google has developed a “Keyword Suggestion Tool,” which it employs to recommend customized keywords to advertisers.95

Keyword advertising has proven to be an effective marketing tool and has generated substantial developments in trademark law.96 Disputes over keyword advertising have arisen in part because search engines do “not always identify sponsored links as advertisements and . . . design[] those appearing at the top of the search results to look like part of the ‘non-sponsored’ [or ‘organic’] search results,”97 leading Internet users possibly to infer that a sponsored link is the most responsive search result or is associated with a trademarked term the user entered.98

91 Id. at 411.92 For example, when an Internet user enters a search on Google, the search engine compares the entered search terms with Google’s

databases of Web sites to “generate[] a listing of the sites matching those terms. These results are known as ‘organic listings.’ . . . Google [also] sells the opportunity to have advertisements appear alongside the organic listings. In the Google system, such advertisements appear as ‘Sponsored Links’ to the right of the organic search results.” Gov’t Employees Ins. Co. v. Google, Inc., 77 U.S.P.Q.2d 1841, 1843 (E.D. Va. 2005) [“GEICO v. Google”].

93 Rescuecom Corp. v. Google, Inc., 456 F. Supp. 2d 393, 397 (N.D.N.Y. 2006).94 Id.95 Id.96 See generally Jacob Jacoby and Mark Sableman, Keyword-Based Advertising: Filling in Factual Voids (GEICO v. Google), the

traDemark reporter 681–751 (2007); Eric Goldman, Deregulating Relevancy in Internet Trademark Law, 54 emory L.J. 507 (Winter 2005).

97 Rescuecom Corp., 456 F. Supp. 2d at 397.98 As this article was being written, the gourmet fruit seller, Harry and David, filed suit against its rival Hickory Farms, Inc., alleging that

Hickory Farms misleads consumers who search for “Harry and David” by directing them to Hickory Farms’ website rather than to Harry and David’s site. See Harry & David v. Hickory Farms, Inc., No. 09-cv-3011 (D. Or. 2009).

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Thus far, it appears that the use of another’s mark in the text of a keyword-triggered advertisement or sponsored link likely will result in a finding of trademark infringement.99 For example, in GEICO v. Google, the search engine Google allowed GEICO’s competitor insurance companies to purchase “GEICO” as a keyword which, when entered as a search term, would trigger competitors’ advertisements under the “sponsored links” shown next to the “organic listings” generated by the search.100 GEICO contended this practice violated the Lanham Act by misleading consumers to infer an association between those “sponsored links” (and the insurance companies they led to) and GEICO. Google, on the other hand, maintained “that the Internet is still governed by traditional trademark infringement and fair competition principles,” pursuant to which “placing an advertisement—especially one that does not mention a competitor by name—next to a competitor’s own advertisement does not violate the Lanham Act.”101 Following a bench trial, the court held that “‘Sponsored Links’ that do not reference GEICO’s marks in their headings or text” do not create a likelihood of confusion and thus are non-infringing.102 But “the use of GEICO’s trademarks in the heading or text of advertisements that appear when a user searches on ‘GEICO’ does violate the Lanham Act . . . .”103

While courts have been in agreement for some time that displaying another’s mark in a sponsored link or ad constitutes a Lanham Act violation, until recently there has been a split among courts over whether trademark infringement has occurred when a defendant’s “sponsored link” or keyword-triggered advertisement does not display plaintiff’s mark, but employs it only in the directory of keywords that trigger the sponsored link or ad. For instance, district courts in the Second Circuit have held that a defendant’s inclusion of another’s trademark in a list of keyword terms that trigger sponsored links does not constitute trademark infringement,104 while the Ninth Circuit in Playboy Enterprises, Inc. v. Netscape Communications Corp. held that merely selling another’s trademark as a keyword to be used in an internal keyword directory will give rise to a cognizable claim.105

At the heart of this issue are courts’ interpretations of the term “use in commerce” in the Lanham Act—a controversy with roots in the pop-up ad context. Specifically, drawing on the Second Circuit’s 1-800 Contacts pop-up ad decision, district courts in the Second Circuit have strictly interpreted the “use in commerce requirement” in favor of defendants, while courts outside of the Second Circuit generally have interpreted that requirement more leniently in favor of plaintiffs.

In Rescuecom Corporation v. Google, Inc., for example, the plaintiff sued Google for its practice of allowing advertisers (including plaintiff’s competitors) to bid on and purchase terms, including trademarks, that an Internet user could enter as a search term.106 In granting Google’s motion to dismiss, the Northern District of New York found that Google’s “use” of Rescuecom’s mark was

99 See mCCarthy, supra note 74, § 25:70.25.100 77 U.S.P.Q.2d at 1843, 1847–48.101 Id.102 Id. at 1847.103 Id. at 1842.104 See, e.g., Rescuecom Corp. v. Google, Inc., 456 F. Supp. 2d 393, 403 (N.D.N.Y. 2006); Merck & Co. v. Mediplan Health Consulting, Inc.,

425 F. Supp. 2d 402, 415 (S.D.N.Y. 2006).105 354 F.3d 1020, 1029 (9th Cir. 2004) (reversing district court’s summary judgment in favor of defendants).106 456 F. Supp. 2d at 397–98.

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purely internal: “[T]here is no allegation that any of the links among the search results, except those belonging to plaintiff, display plaintiff’s trademark or that defendant’s activities effect the ‘appearance or functionality’ of plaintiff’s website.”107 Accordingly, as in 1-800 Contacts, the court held that use of a trademarked term in a computer directory or program, which is not displayed or communicated to the public, does not violate the Lanham Act.108

The Southern District of New York reached a similar conclusion in Merck & Co. v. Mediplan Health Consulting, Inc.109 There, the court also granted the defendant’s motion to dismiss, reasoning that the internal use of plaintiff’s ZOCOR mark as a keyword to trigger the display of sponsored links does not constitute “use in commerce” under the Lanham Act.110

But elsewhere, courts have found that merely selling or purchasing others’ trademarks as keywords constitutes “use” under the Lanham Act, and is sufficient to survive a Rule 12 or summary judgment motion. For instance, in Edina Realty Inc. v. TheMLSonline.com,111 the District of Minnesota denied the defendant’s summary judgment motion where the defendant had purchased the plaintiff’s trademarks as search terms from Google and Yahoo. Similarly, in 800-JR Cigar, Inc. v. GoTo.com, Inc.,112 the District of New Jersey held that GoTo.com used the plaintiff’s trademarks in commerce by selling them as search terms. And, in Google Inc. v. American Blind & Wallpaper Inc.,113 the Northern District of California denied Google’s motion to dismiss American Blinds’ claims that Google’s sales of ad words, including American Blinds’ trademarked terms, constituted trademark infringement. Other courts have reached similar results.114

On the eve of this article’s publication, the Second Circuit issued a ruling that appears to have resolved the split in authority. In Rescuecom Corp. v. Google, Inc., the Second Circuit vacated the above-described dismissal by the Northern District of New York of Rescuecom’s keyword advertising claim against Google.115 In vacating the district court’s decision, the Second Circuit relied on two key factual distinctions between Rescuecom and 1-800 Contacts. “First, in contrast to 1-800, where we emphasized that the defendant made no use whatsoever of the plaintiff’s trademark, here what Google is recommending and selling to its advertisers is Rescuecom’s trademark.”116 In other words, because the plaintiff in 1-800 Contacts did not claim its website as a trademark, the defendant’s use of that website in its internal directory of triggering terms could not be considered “use” of a trademark.117 “Second, in contrast with the facts of 1-800, where the defendant did not

107 Id. at 401.108 Id. at 402–03. 109 425 F. Supp. 2d at 415.110 Id.111 80 U.S.P.Q2d 1039, 1045–46 (D. Minn. 2006).112 437 F. Supp. 2d 273, 285 (D.N.J. 2006).113 74 U.S.P.Q.2d 1385, 1391–94 (N.D. Cal. 2005).114 Buying for the Home, LLC v. Humble Abode, LLC, 459 F. Supp. 2d 310, 323 (D.N.J. 2006) (holding that defendant made use of plaintiff’s

trademarks by purchasing them as search terms); Florists’ Transworld Delivery, Inc. v. Fleurop-Interflora, 261 F. Supp. 2d 837, 850 (E.D. Mich. 2003) (denying defendant’s motion to dismiss plaintiff’s Michigan Consumer Protection Act claim for “unfair” or “deceptive” trade practices when defendant operated domain names allegedly incorporating plaintiff’s trademark).

115 No. 06-4881-cv, slip op., at 15 (2d Cir. Apr. 3, 2009).116 Id. at 11. 117 Id.

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‘use or display,’ much less sell, trademarks as search terms to its advertisers, here Google displays, offers, and sells Rescuecom’s mark to Google’s advertising customers.”118 Indeed, Google even “encourages the purchase of Rescuecom’s mark through its Keyword Suggestion Tool.”119

This newly emerging consensus appears to make clear that offering for sale or selling keywords constitutes a “use in commerce” that may give rise to infringement. Whether a given use is likely to cause confusion still requires a case-by-case analysis, and other areas of keyword-advertising law, such as whether the sale or purchase of potentially misrepresentative keywords will give rise to cognizable Lanham Act claims, remain relatively unclear.

D. Screenscraping

Moving from relatively subtle forms of Internet-based potential trademark infringement to more overt acts, screenscraping—also referred to as “web scraping” or “web crawling”—refers to extracting content from another’s website in order to display the content elsewhere. Scraping is typically conducted as a shortcut to collecting one’s own data. When the information collected is copyrighted, trademarked, or serves a source-identifying purpose, screenscraping is generally prohibited. For example, the terms of use for the Yellowpages.com website provide in part:

You may view, use, copy, and distribute the Materials found on YELLOWPAGES.COM Web sites for internal, noncommercial, informational purposes only. You are prohibited from data mining, scraping, crawling, or using any process or processes that send automated queries to the YELLOWPAGES.COM Web site. You may not use the YELLOWPAGES.COM Web sites to compile a collection of listings, including a competing listing product or service.120

But enforcing such prohibitions is another issue. A number of courts have relied on principles of trespass to address screenscraping.121 Analogous to decisions in the pop-up ad and keyword advertising contexts, a finding that scraping constitutes a “use” of the site (and that the scraper is bound by the site’s terms of use) has been critical to the outcomes of court decisions; indeed, a user may be bound by the terms even if it did not specifically agree to them.122

118 Id. 119 Id.120 See http://www.yellowpages.com/about/terms.121 See, e.g., Ticketmaster Corp. v. Tickets.Com, Inc., No. 99 CV7654, 2000 U.S. Dist. LEXIS 12987 (C.D. Cal. Aug. 10, 2000), aff’d, 248

F.3d 1173 (9th Cir. 2001) (finding that a trespass claim based upon web crawling had “some merit” but not enough to justify the issuance of a preliminary injunction); eBay, Inc. v. Bidder’s Edge Inc., 100 F. Supp. 2d 1058 (N.D. Cal. 2000) (finding that a web crawler’s generation of 80,000 to 100,000 requests a day to a website constituted a trespass to chattels); Oyster Software v. Forms Processing, No.C-00-0724 JCS, 2001 U.S. Dist. LEXIS 22520 (N.D. Cal. Dec. 6, 2001) (although web crawlers placed only a “negligible” load on a website’s servers, no more than mere “use” of a plaintiff’s computer system was necessary to establish a trespass claim); American Airlines, Inc. v. Furichase, Inc., No. 167-194022-02 (Tex. 7th Dist. Ct., Texas, Mar. 8, 2003).

122 See Cairo, Inc. v. Crossmedia Servs., Inc., No. 04-04825, 2005 WL756610 (N.D. Cal. Apr. 1, 2005) (repeated use of a site’s web pages can form the basis for imputed knowledge of the site’s terms even if the “use” is by a crawler that does not read the terms); Compuserve, Inc. v. CyberPromotions, Inc., 962 F. Supp. 1015 (S.D. Ohio 1997) (one need not show interference with property in order to establish trespass under California law; use is sufficient).

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The Computer Fraud and Abuse Act (“CFAA”)123 and parallel state law provisions124 also have been used to assert claims against screenscrapers. In E F Cultural Travel B.V. v. Zefer Corp.,125 for example, a travel agency scraped its competitor’s site to collect tour prices in order to set its own prices consistently lower. The district court granted a preliminary injunction because the scraper exceeded the “reasonable expectation” of authorized access of the scraped site. In doing so, the district court relied on 18 U.S.C. § 1030(a)(4):

Whoever . . . knowingly and with intent to defraud, accesses a protected computer without authorization or exceeds authorized access, and by means of such conduct furthers the intended fraud and obtains anything of value, unless the object of the fraud and the thing obtained consists only of the use of the computer and the value of such use is not more than $5000 in any 1-year period . . . shall be punished . . .

“Exceeds authorized access,” as defined by the CFAA, means “to access a computer with authorization and to use such access to obtain or alter information in the computer that the accessing party is not entitled so to obtain or alter.”126 The district court concluded, and the court of appeals affirmed, that a web crawler obtained information it was not entitled to obtain under the terms of use of the site and therefore exceeded authorized access.127

More recently, a Texas district court in Southwest Airlines Co. v. Boardfirst, LLC128 relied on a breach of contract theory to address screenscraping. There, the court found that the defendant had clearly agreed to the site’s terms of use when it used the site after having received a demand letter that notified it of the same, and that use inconsistent with those terms would constitute a breach of contract.

Some businesses and industries welcome screenscraping as a means of facilitating the flow of information.129 But when a business’s valuable intellectual property is at stake, would-be plaintiffs should look beyond conventional copyright and trademark law remedies to options for causes of actions sounding in trespass, breach of contract, and the CFAA.

123 18 U.S.C. § 1030.124 Most states have statutes comparable to the Computer Fraud and Abuse Act. See e.g. California Comprehensive Computer Data Access

and Fraud Act, Cal. Penal Code § 502(c) (West 1999 and Supp. 2008); Georgia Computer System Protection Act, ga. CoDe ann. § 16-9-93 (2007), texaS penal CoDe ann. § 33.02(a) (Vernon 2003). A complaint for screenscraping should also assert a claim under the applicable state statute, assuming the statute provides a private cause of action.

125 318 F. 3d 58 (1st Cir. 2003).126 18 U.S.C. § 1030[e][6] (2006).127 The court of appeals determined that while the plaintiff could not prove “damage” as defined under the CFAA, it nevertheless likely

could prove a compensable “loss,” an undefined term under the statute. Plaintiffs generally seek to meet the $5,000 damages threshold by showing that expenses associated with investigation and blocking of the unauthorized access were at least $5,000.

128 Civ. Action No. 3:06-CV-0891-B, 2007 WL 4823761. (N.D. Tex. Sept. 12, 2007).129 See, e.g., Outlaw.com, Ryanair Begins Screen-Scraping Lawsuit, the regiSter, July 9, 2005, available at http://www.theregister.

co.uk/2008/07/09/ryanair_screen_scraping_bravofly/ (“Many websites in the airline and insurance businesses welcome screen-scraping by aggregators as a way of generating new business;” however, the airline plaintiff in the screenscraping case pending in Ireland discussed in this article found the practice objectionable).

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E. Contributory Infringement

The extension of liability for trademark infringement to parties other than direct infringers based on the theory of contributory infringement is well-established. In fact, although contributory infringement has not been expressly operative in the pop-up and keyword advertising contexts discussed above, the fundamental principles of holding liable parties beyond a directly infringing advertiser operate in those contexts much as they do here.

Contributory infringement originated in landlord-tenant law. With the prevalence and rapid growth of the Internet, courts have extended “landlord liability” theory to online marketplaces where sufficient control can be established. It is immaterial “whether the venue is online or in brick and mortar.”130 As set forth by the Supreme Court in Inwood Laboratories, Inc. v. Ives Laboratories, Inc., a defendant is liable for contributory trademark infringement if it “intentionally induces another to infringe a trademark” or “continues to supply its product to one whom it knows or has reason to know is engaging in trademark infringement.”131 Courts have applied Inwood to impose liability on landlords of flea markets and stores where the landlord knew or had reason to know that its premises were being used for the sale of infringing goods.132

Applying the contributory infringement theory to Internet disputes, courts have required a plaintiff to show: (1) that the defendant “exercises sufficient control and monitoring over its website” used by third parties to infringe, and (2) that the defendant continues to supply services to customers it knows or has reason to know are infringing a plaintiff’s trademarks.133

The recent case Tiffany v. eBay most clearly sets forth and applies the law on contributory trademark infringement in the context of the Internet. In that case, Tiffany, a famous jeweler, sued eBay, the prominent online marketplace, alleging contributory trademark infringement based on the pervasive sale of counterfeit Tiffany goods on eBay’s website, claiming that eBay had knowledge of such sales but failed to investigate or remedy the problem.134 Tiffany sought injunctive relief requiring eBay to take affirmative steps to screen for and prevent the listing of counterfeit Tiffany silver jewelry and to remove any such listings appearing on eBay’s website. Specifically, Tiffany wanted eBay to preemptively ban sellers of five or more Tiffany items and to immediately suspend sellers it identified through eBay’s “Verified Rights Owner Program” (“VeRO”) program.135

The Southern District of New York refused to find eBay contributorily liable with respect to the specific instances of infringement identified by Tiffany through the VeRO program because eBay promptly removed the infringing listing, issued warnings and other punishments to the sellers, and

130 Tiffany Inc. v. eBay, Inc., 576 F. Supp. 2d 463, 505 (S.D.N.Y. 2008).131 456 U.S. 844, 854–55 (1982). 132 See Fonovisa, Inc. v. Cherry Auction, Inc., 76 F.3d 259, 265 (9th Cir. 1996) (reversing dismissal and holding that plaintiff had stated a

claim for contributory trademark infringement).133 Tiffany, 576 F. Supp. 2d at 505–508.134 Id. at 469. 135 Id. at 483, 488. eBay’s VeRO (“Verified Rights Owner”) Program permits trademark owners to file Notices of Claimed Infringement

(“NOCIs”) when an owner sees a counterfeit listing on eBay’s site. In response, eBay removes the listing or otherwise cancels any transaction that has already occurred and/or pursues disciplinary action against the seller. Id. at 478.

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notified the buyers.136 Thus, eBay did not continue to supply its services to those it knew or had reason to know were infringing through the VeRO program. Tiffany further declined to impute to eBay knowledge of infringement based on generalized assertions. Specifically, the court decided that “generalized assertions of infringement made by Tiffany” were not “sufficiently specific to impute to eBay knowledge of any and all instances of infringing sales on eBay.”137 Among its evidence, Tiffany provided: (1) demand letters to eBay asserting rampant counterfeiting on eBay’s website; (2) assertions that sellers selling five or more Tiffany items are presumptively selling counterfeits; (3) results from its buying program showing 73%+ of Tiffany items on eBay were counterfeit; and (4) a submission of over 284,000 notices through the VeRO program over four years.138

The court was not persuaded by Tiffany’s evidence. First, the court summarily rejected that demand letters can provide the requisite knowledge for liability. Second, it found that Tiffany’s “five-or-more” assertion was ambiguous. In particular, it found that there were legitimate sales of five or more genuine Tiffany goods, that Tiffany itself did not regularly enforce the five-or-more rule, as its corporate department regularly sold larger quantities, and Tiffany’s CEO admitted the rule was a “shorthand solution” for making eBay do a better job.139 The court noted that imposing the rule would have resulted in the elimination of legitimate Tiffany sales on eBay and declined to impute knowledge to eBay based on this evidence. Finally, the court found that the buying program results and Tiffany’s large number of submissions through the VeRO program were insufficient because they only provided notice that a high percentage of counterfeit merchandise was being sold. The VeRO submissions were simply complaints based on a “good faith belief” that the listing was counterfeit and was not a definitive finding that the listing was in fact counterfeit.140 eBay was “‘not require[d] . . . to refuse to sell to dealers who merely might pass off” goods.141 The court emphasized that genuine Tiffany product was found on eBay’s website.142

In rejecting Tiffany’s argument that eBay engaged in willful blindness, the court focused on eBay’s proactive steps to prevent the sale of counterfeit goods on its website. These included: eBay’s requirement that all users sign a User Agreement which prohibited violations of third party rights; that eBay suspended sellers in an appropriate manner, eBay’s substantial investment ($20 million per year) to combat infringement; eBay’s fraud engine which implemented Tiffany-specific filters to ferret out illegal listings; eBay’s VeRO program; and eBay’s encouragement of rights owners to create “About Me” pages.143 The court also pointed out that Tiffany invested little in monitoring eBay’s website for infringement (between 1.15 and 1.6 full-time employees per month).144

136 Id. at 515–516. 137 Id. at 511. 138 Id. at 481–87.139 Id. at 511–12. 140 Id. at 489. 141 Id. at 509 (internal citations omitted).142 Id. at 513. 143 Id. at 489–91. 144 Id. at 484–85.

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Although the Tiffany court refused to hold eBay contributorily liable based on eBay’s generalized knowledge of infringement, trademark owners should not necessarily dismiss contributory infringement as a potential vehicle for enforcing their rights. Rather, would-be plaintiffs should learn from the lessons of Tiffany, particularly with respect to demonstrating exhaustive policing efforts of their own and to constructing buying-program surveys aimed at demonstrating a defendant’s knowing disregard of a plaintiff’s rights.

F. Virtual Worlds

Finally, in what may be the next frontier in Internet branding, “virtual worlds,” even in their relatively short existence, have become increasingly prevalent and have evolved to become relatively robust in their marketing opportunities. Early “virtual worlds” took the form of text-based fantasy role-playing games, which evolved into large multi-player online role-playing games, such as World of Warcraft, 145 financed by player subscriptions. Other virtual worlds, such as There,146 involve more free-form socializing and are funded by advertising revenues147 and the sale of virtual “objects.”148 More recent social virtual worlds have been brand-devoted promotional virtual social worlds, such as Coca-Cola’s Coke Studios,149 Disney’s Virtual Magic Kingdom,150 and Nickelodeon’s Nicktropolis.151

In both game-based and social virtual worlds, the creator of the game or virtual community generally retains most of the creative control over the environment and provides users relatively limited ability to create new content.152 Thus, most of the potential trademark issues in these environments emanate from the companies that create, own, and run the virtual worlds. These companies have a vested interest in preserving the profitability of their businesses by avoiding primary liability for infringement and limiting their exposure to secondary liability by restricting their users’ creative freedom. Moreover, to the extent these virtual worlds rely on advertising revenue, virtual-world

145 World of Warcraft, http://www.worldofwarcraft.com/index.xml (last visited Mar. 26, 2009).146 There.com, http://www.there.com/ (last visited Mar. 26, 2009). Google also launched a social virtual world in July of 2008, called Lively,

which Google ended on December 31, 2008. See Vindu Goel, How Google Decides to Pull the Plug, N.Y. Times, Feb. 15, 2009, at BU4; Google, Inc., The Official Google Blog: Lively No More, Nov. 19, 2008, http://googleblog.blogspot.com/2008/11/lively-no-more.html.

147 For example, There.com offers six different types of marketing programs to its advertising partners, including a “Virtual Merchandise Program,” a “Hosted Event Program,” and a “World Integration Program.” See There.com, Your Brand in There, http://www.there.com/yourBrand.html (last visited Mar. 26, 2009).

148 Through There.com’s “Developer’s Program,” users can submit designs for new avatar clothing, vehicles, and other objects. Once There.com approves a submission, a user with a basic subscription can use the object for his own use within the environment, and premium members can sell approved their designs to other users to earn “Therebucks.” Therebucks have a relationship to real-world currency, as they can be purchased with a credit card as well. There.com charges a submission fee, a “wholesale” fee for the creation of additional copies of the object for sale, and an auction fee for sale of user-designed objects. See There.com, Developers, http://webapps.prod.there.com/developer/home.cgi (last visited Mar. 26, 2009).

149 Coke Studios, http://www.mycoke.com/index.jsp?tunnel=cokestudios (last visited Mar. 26, 2009); see also Virtual Worlds Review, Coke Studios, http://www.virtualworldsreview.com/cokestudios/ (last visited Mar. 26, 2009).

150 Virtual Magic Kingdom, http://disney.go.com/games/?name=VMKHomePage (last visited Mar. 26, 2009); see also Virtual Worlds Review, Virtual Magic Kingdom, http://www.virtualworldsreview.com/vmk/ (last visited Mar. 26, 2009).

151 Nicktropolis, http://www.nick.com/nicktropolis/game/ (last visited Mar. 26, 2009).152 See, e.g., There.com, Submission Guidelines, http://webapps.prod.there.com/developer/developer_help_sg.xml (last visited Mar. 26,

2009) (listing content restrictions for user-created design submissions).

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creators have additional interest in making their “worlds” safe and inviting to the marketing campaigns of “real world” brands.153

A different situation exists in user-generated virtual worlds, such as Linden Lab, Inc.’s “Second Life,” which give its users far greater freedom in developing content.154 User-generated virtual worlds create both unique branding opportunities and new trademark protection problems.

In Second Life, companies like Coca-Cola and Nestle have enjoyed success in implementing non-traditional marketing and advertising strategies that focus on customer relationships, entertainment, and increasing brand awareness and affinity. These strategies involve developing Second Life avatar “brand ambassadors” to interact with Second Life users and hosting contests and events in Second Life—such as Coca-Cola’s “Virtual Thirst” competition155 and Nesquik’s QuikSk8 Park virtual skate park, user-generated graffiti art contest, and Nesquik bottle treasure hunt.156 By contrast, many brands that have attempted to create exclusively commercial presences in Second Life have been disappointed in their forays into the 3D virtual world.157

In addition to creating new opportunities for companies to market and expand their brand’s reach, the creative freedom given to Second Life users also creates an additional—and relatively un-policed—front in brand protection. While Second Life is a “virtual world,” it has a real economy, with an official currency (the Linden), a currency exchange (the LindeX), and daily market reports (the Linden Dollar Exchange reports a rate between 250-270).158 Real money is changing hands in this virtual world through the buying and selling of virtual goods and services, and it is happening to the tune of $35 million a month.159 This real economy brings many uses of brands and trademarks in the Second Life marketplace within the trademark definition of “use in commerce,” distinguishing it from cases of unauthorized non-commercial uses of trademarks in video games and in other virtual communities which courts held to be non-trademark uses protected by freedom of expression.160

153 See Greg Lastowka, Virtual Trademarks, 24 Santa Clara Computer & high teCh. l.J. 749, 767 (2008); see also There.com, Submission Guidelines, http://webapps.prod.there.com/developer/developer_help_sg.xml (last visited Mar. 26, 2009) (“The relationship we have with our partners is very important to us and we want to be respectful and responsible towards them. As a result, we cannot allow advertisements for companies that are not currently our partners.”).

154 Linden Lab, Inc., Second Life, http://secondlife.com/ (last visited Mar. 26, 2009). Linden Lab states on Second Life’s Frequently Asked Questions webpage that “Second Life virtual world provides almost unlimited freedom to its Residents. This world really is whatever you make it. . . . You also own anything you create—Residents retain intellectual property rights over their in-world creations.” Linden Lab, Inc., Second Life FAQ, http://secondlife.com/whatis/faq.php (last visited Mar. 26, 2009).

155 In April 2007, Coca-Cola encouraged Second Life residents to use its brand in user-created content for its “Virtual Thirst” contest, which solicited submissions of “virtual vending machines” that “could dispense—not Coca-Cola—but the ESSENSE of Coca-Cola: refreshment, joy, unity, experience.” Adam Reuters, UPDATE—Coca-Cola Gives Away Its Trademark in SL?, Second Life News Center, June 28, 2007, http://secondlife.reuters.com/stories/2007/06/28/coca-cola-gives-away-its-trademark-in-sl/.

156 See Moderne Interactive, Nestle Case Study, http://modernecommunications.com/case-studies/Case-Study-Nesquik.pdf (last visited Mar. 26, 2009) (describing a Nestle brand Second Life case study in which Moderne Interactive gauged the impact of various creative solutions for increasing real-world brand awareness and brand affinity by developing a Second Life brand presence and holding interactive events to engage Second Life residents).

157 See Reuters Newswire, Companies Shifting Virtual World Strategies, Second Life News Center, Oct. 11, 2007, http://secondlife.reuters.com/stories/2007/10/11/companies-shifting-virtual-world-strategies/ (last visited Mar. 26, 2009).

158 Linden Lab, Inc., Second Life: LindeX™ Market Data, http://secondlife.com/statistics/economy-market.php.159 Linden Lab, Inc., Second Life: The Marketplace, http://secondlife.com/whatis/marketplace.php (last visited Mar. 26, 2009) (“In 2008

more than USD $100 million worth of L$ were both and sold on the LindeX.”). 160 See E.S.S. Entm’t 2000, Inc. v. RockStar Videos, Inc., 444 F. Supp. 2d 1012 (C.D. Cal. 2006) aff’d, 547 F.3d 1095 (9th Cir. 2008); Marvel

Enters., Inc. v. NCSoft, Corp., 74 U.S.P.Q.2d 1303 (C.D. Cal. 2005); see also Lastowka, supra note 148, at 779.

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In 2007, a search within Second Life revealed the proliferation of unauthorized virtual goods for sale under the marks of well-known brands, including 16 Second Life stores selling FERRARI virtual cars, 40 stores advertising ROLEX and CHANEL branded virtual watches, and 50 stores selling RAY BAN, PRADA, and GUCCI brand virtual sunglasses.161 While the low U.S. dollar Second Life market price of these infringing virtual goods (ranging from $7.75 for the FERRARI virtual car to $.75 each for the virtual counterfeit designer sunglasses),162 may seem insignificant to brand owners, ignoring unauthorized commercial uses of a brand’s trademarks could lead to more significant problems in the future. Failure to police and protect a brand’s trademarks in the face of unauthorized commercial uses could potentially implicate future laches and acquiescence defenses to trademark infringement, lead to dilution of a mark’s strength, increase the possibility that tarnishing uses could arise, and affect a mark’s fame and ability to identify a unique source.

When it comes to the methods for protecting brands from harm from unauthorized use in virtual worlds, however, companies have chosen varied ways to approach the situation. For example, office furniture maker Herman Miller responded to unauthorized Second Life sales of virtual copies of its AERON chairs and other products by sending cease and desist letters to the infringers, after first opening its own Second Life store and offering to exchange, for free for a limited time, the knock-off Herman Miller virtual goods for authentic Herman Miller virtual goods.163 Contrast this approach with that of Coca-Cola in its “Virtual Thirst” competition discussed above, in which Coca-Cola gave Second Life residents limited permission to use its trademark.164 Regardless of the approach a brand owner takes in protecting its mark in virtual worlds, the reality of the commerce in Second Life requires at the very least that brand owners monitor the use of their marks in virtual worlds and make efforts to educate virtual world users regarding their brand property.165

II. Conclusion

Even though the law surrounding Internet branding has existed for less than two decades, already it has created entirely new areas of practice and distinct lines of precedent. Given its still nascent state, the challenges facing brand owners on the Internet continue to evolve and require vigilance in monitoring not only a brand’s marks and accompanying goodwill but the steady fluctuations and new developments in the legal terrain.

161 BenJamin DuranSke, virtual law: navigating the legal lanDSCape of virtual worlDS 150 (2008).162 See id.163 See John W. Crittenden, Real I.P., Virtual Worlds—Issues in Litigating Trademark and Unfair Competition Cases in Second Life and Like

Spaces, in ali & aBa Continuing legal eDuCation CourSe of StuDy, litigating traDemark, internet, anD unfair Competition CaSeS 239, 242 (2008).

164 See Adam Reuters, supra note 150. 165 See Max Vern, Second Life—A New Dimension for Trademark Infringement, 90 J. pat. & traDemark off. SoC’y 51, 55 (2008).

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INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

PATENT

Inventorship: Navigating the Muddy Waters of Inventorship Determination and Correction

Jamie L. Greene, Kathryn H. Wade, and Christopher M. Durkee

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Inventorship: Navigating the Muddy Waters of Inventorship Determination and CorrectionJamie L. Greene, Kathryn H. Wade, and Christopher M. Durkee1*

I. Introduction

The United States Constitution provides inventors with an exclusive right to their discoveries.2 Because of this, an application for a patent must be made by the inventor or, when the inventor is dead, cannot be located, or refuses to cooperate, by persons on behalf of the inventor.3 When two or more people make an invention, they must file jointly, “even though (1) they did not physically work together or at the same time, (2) each did not make the same type or amount of contribution, or (3) each did not make a contribution to the subject matter of every claim of the patent.”4 It is particularly important that the inventors named on a patent application be accurate because a patent can be held invalid if it names one who is not an inventor or if it fails to name someone who is an inventor, although these errors may be corrected if it can be shown that they were not committed with an intent to deceive.5

In many other countries, patent applications are filed in the name of the corporate entities who own the technology. But in the U.S., even though the employer of the inventor may be the real party in interest and own the patent for which its inventors apply, a U.S. patent always names one or more individuals as inventors, and the corporate owner is only listed as an “assignee” (i.e., owner).6

The determination of who, among the many individuals who participated in developing an invention, is an inventor carries substantial legal importance, yet it may present difficulties even to seasoned patent attorneys. The joint inventorship determination has been characterized by at least one court as “one of the muddiest concepts in the muddy metaphysics of the patent law.”7 Although procedures exist to correct inventorship of both patent applications and issued patents, these procedures present their own difficulties, often requiring the reconstruction of past events and sometimes resulting in the loss of patent term. Correction also can be costly and time consuming, depending upon when the error is identified. These difficulties are further compounded if an incorrectly named inventor is no longer associated with the entity that owns the application. Incorrect inventorship also can cause the ownership of a patent to be different than expected, because every inventor has an equal, undivided interest until that interest is conveyed.

1 * The authors gratefully acknowledge the contributions of John S. Pratt and Kristin M. Crall to an earlier edition of this work. 2 U.S. Const. art. 1, § 8, cl. 8.3 35 U.S.C. §§ 111, 118 (2000); 37 C.F.R. § 1.47 (2008); U.s. Dep’t of CommerCe, U.s. patent & traDemark offiCe, manUal of patent

examining proCeDUre § 409.01-.03 (8th ed., rev. 6 2007) [hereinafter MPEP].4 Id. § 116.5 Id. § 256.6 Corporate policies usually dictate that inventors assign ownership of a patent to the company.7 See Mueller Brass Co. v. Reading Indus., Inc., 352 F. Supp. 1357, 1372 (E.D. Pa. 1972), aff’d, 487 F.2d 1395 (3d Cir. 1973). Recently,

the Federal Circuit agreed: “The line between actual contributions to conception and the remaining, more prosaic contributions to the inventive process that do not render the contributor a co-inventor is sometimes a difficult one to draw.” Eli Lilly & Co. v. Aradigm Corp., 376 F.3d 1352, 1359 (Fed. Cir. 2004).

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As a result, the difficult task of properly investigating inventorship and naming the correct inventors should be done prior to filing a patent application to minimize reliance on correction procedures. This may require political and communication skills, as well as an understanding of the legal niceties of inventorship, particularly where financial rewards or increased prestige result from being named as an inventor. If a valid patent is to be obtained, however, the temptation to name everyone involved with the project as an inventor (or to exclude one who is truly an inventor to avoid creating an ownership interest in the resulting patent) must be overridden by the legal reality that naming incorrect inventors can be fatal to validity if it can be proven that the incorrect naming was done with deceptive intent.

II. Inventorship is Determined by Conception

Inventing involves at least two legal stages or activities: conception and reduction to practice. A third activity, diligence in reducing the invention to practice, sometimes becomes important in determining who is the first to invent.

Conception is the mental part of inventing, the formation in the mind of the inventor of a definite and permanent idea of the complete and operative invention as it is to be subsequently claimed. Conception is complete if the inventor could make a complete disclosure of his idea to those of ordinary skill in the art that is sufficiently detailed to allow them physically to make the invention without undue experimentation or inventive activity of their own.8 This hypothetical disclosure must be possible with a high degree of particularity; a disclosure that includes merely research plans that should be pursued or that only states general goals would not indicate that conception was complete at that time.9

Reduction to practice can be actual or constructive. Actual reduction to practice occurs when someone, e.g., a technician working under the direction and supervision of the inventor, actually carries out the conception of the inventor and places it into tangible form.10 Constructive reduction to practice occurs when a patent application is filed describing the invention in a way that allows one of ordinary skill in the art to carry out an actual reduction to practice without extensive further research or invention.11

In determining inventorship, the rule is that inventorship is determined by conception.12 Put another way, inventors are only those who conceive or contribute to the conception of the invention. Those who merely reduce the invention to practice, working at the direction of those who conceived, are not inventors, unless they contribute some original conception of the invention that ultimately is claimed. In short, “conception is the touchstone” to inventorship.13

Some nonexclusive examples of acts that are not considered acts of inventorship include:

8 Mergenthaler v. Scudder, 11 App. D.C. 264, 1897 C.D. 724, 731 (D.C. Cir. 1897); see also In re Tansel, 253 F.2d 241, 242 (C.C.P.A. 1958).

9 See Burroughs Wellcome Co. v. Barr Labs., Inc., 40 F.3d 1223, 1228 (Fed. Cir. 1994).10 See, e.g., De Solms v. Schoenwald, 15 U.S.P.Q.2d 1507, 1510 (Bd. Pat. App. & Inter. 1990).11 See Burroughs Wellcome Co., 40 F.3d at 1228.12 See Fiers v. Revel, 984 F.2d 1164, 1168 (Fed. Cir. 1993).13 See Burroughs Wellcome Co., 40 F.3d at 1227.

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(1) supplying a product available in the marketplace and explaining its use or merely explaining well-known principles;14

(2) making only minor or superficial changes;15 or (3) suggesting an idea of a result to be accomplished rather than providing the steps or

the way to accomplish that result.16

Because conception is a mental act, courts may require corroborating evidence of a contemporaneous disclosure that would enable one skilled in the art to make the invention.17 One way to establish corroborating evidence (as well as to avoid or minimize potential disputes over inventorship) is to keep good contemporaneous records, such as technical notebooks with non-removable pages that are signed and witnessed regularly (e.g., “Read and understood, Brady Johnson, January 1, 2005.”). These records should preferably refer to “investigators” and not “inventors” to avoid a pre-mature conclusion of inventorship. The witnesses should be individuals capable of understanding the research document and what it contains, but should not include those who are working on the project and therefore might ultimately be named as inventors of the patent application.

Although in most areas of technology, conception occurs before reduction to practice, both may occur simultaneously for purposes of inventorship, particularly in some areas of technology characterized as “unpredictable,” such as the biotechnology and chemical arts.18 “[C]onception of a chemical compound requires that the inventor be able to define it so as to distinguish it from other materials, and to describe how to obtain it.”19 In addition, the Federal Circuit reasoned in Amgen that a gene is a chemical compound, and therefore, it is not sufficient to define a gene solely by its principal biological property.20 The court held that “when an inventor is unable to envision the detailed [DNA sequence] of a gene so as to distinguish it from other materials, as well as a method for obtaining it, conception has not been achieved until reduction to practice has occurred, i.e., until after the gene has been isolated.”21 The conception must be sufficient to allow one of ordinary skill to make and use the claimed invention.

Similarly, the Federal Circuit held that DNA encoding a particular protein cannot be conceived until the actual nucleotide sequence has been determined.22 “[A]n adequate written description of genetic

14 See e.g., Hess v. Advanced Cardiovascular Sys., Inc., 106 F.3d 976, 981 (Fed. Cir. 1997); Ethicon Inc. v. U.S. Surgical Corp., 135 F.3d 1456, 1460 (Fed. Cir. 1998).

15 See Hoop v. Hoop, 279 F.3d 1004 (Fed. Cir. 2002).16 See Eli Lilly & Co. v. Aradigm Corp., 376 F.3d 1352, 1359 (Fed. Cir. 2004).17 See Burroughs Wellcome Co., 40 F.3d at 1228.18 See Amgen, Inc. v. Chugai Pharm. Co., 927 F.2d 1200, 1206 (Fed. Cir. 1991) (finding that in certain instances, conception is not possible

until the inventor has reduced the invention to practice through a successful experiment, resulting in a simultaneous conception and reduction to practice).

19 Id., citing Oka v. Youssefyeh, 849 F.2d 581, 583 (Fed. Cir. 1988). 20 See also In re Wallach, 378 F.3d 1330, 1335 (Fed. Cir. 2004) (“[I]t is well established in our law that conception of a chemical compound

requires that the inventor be able to define it so as to distinguish it from other materials, and to describe how to obtain it.”) (quoting Amgen, 927 F.2d at 1206).

21 Amgen, 927 F.2d at 1206; see also Chiron Corp. v. Abbott Labs., 902 F. Supp. 1103 (N.D. Cal. 1995).22 Fiers v. Revel, 984 F.2d 1164, 1168 (Fed. Cir. 1993).

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material requires a precise definition, such as by structure, formula, chemical name, or physical properties, not a mere wish or plan for obtaining the claimed chemical invention . . .”23

Two district courts in California have held that the doctrine of simultaneous conception and reduction to practice also applies in the context of claims directed to an isolated virus.24 Both courts held that conception did not occur until the feline immunodeficiency virus was isolated “and its definitive structure, name, chemical and physical properties were determined.”25 These cases provide that, with respect to claims directed to an isolated virus, when an individual provides a concept (e.g., that a virus might be responsible for disease symptoms), but does not contribute to the isolation of the virus or to the determination of its structure, name, or chemical or physical properties, that individual is not an inventor of claims to the isolated virus.26

Simultaneous conception and reduction to practice can occur in other contexts as well, such as where the invention is produced unintentionally, provided that the inventor appreciated or recognized the conception at the time of its occurrence.27 Thus, no conception or reduction to practice of a new form of catalyst for use in reforming naphtha occurred where the patent applicant did not recognize the existence of the new catalyst until years after filing the application.28

III. Sole and Joint Inventorship

As mentioned above, determining whether conception (and therefore inventorship) is sole or joint is difficult but necessary in view of the realities of modern research. Mere involvement with a research project does not qualify an individual as a joint inventor. Clearly, if a single individual conceives and reduces the invention to practice without assistance from any other, that individual is a sole inventor. If a single individual conceives of the invention in sufficient detail that it can be reduced to practice by another, and a second individual assists the first by making the invention in tangible form based on the conception of the first individual, the first individual is still a sole inventor. The second individual is merely functioning as a “pair of skilled hands” for the first individual, and has not contributed to the conception of the invention.29

If, however, it should turn out that the first individual did not have as complete an idea of how to make the invention as he thought, and it is necessary for the second individual to carry out more than routine experimentation in placing the invention into tangible form, the second individual’s contribution may be sufficient for both individuals to be joint inventors.30 For example, if there are failed prototypes, a significant number of unsuccessful experiments, or problems not recognized until the idea is carried out, which leads to someone adding new elements to the originally conceived

23 Enzo Biochem. Inc. v. Gen-Probe Inc., 323 F.3d 956, 964 (Fed. Cir. 2002) (citations and internal quotation marks omitted).24 See Brown v. Regents of the Univ. of Cal., 866 F. Supp. 439 (N.D. Cal. 1994); Regents of the Univ. of Cal. v. Synbiotics Corp., 849 F. Supp.

740 (S.D. Cal. 1994).25 Regents, 849 F. Supp. at 742; see also Brown, 866 F. Supp. at 444. 26 See Regents, 849 F. Supp. at 742; Brown, 866 F. Supp. at 445.27 See, e.g., Dow Chem. Co. v. Astro-Valcour, Inc., 267 F.3d 1334, 1340-41 (Fed. Cir. 2001), citing to Heard v. Burton, 333 F.2d 239

(C.C.P.A. 1964).28 See id.29 See Harris v. Clifford, 363 F.2d 922, 927 (C.C.P.A. 1966).30 See Mattor v. Coolegem, 530 F.2d 1391, 1393-94 (C.C.P.A. 1976).

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idea, and those elements are included in the claims of the patent application, then those contributing to the solutions are likely to be considered inventors of those new elements.

Although it may seem obvious, inventorship must be determined for the invention defined by the claims at the end of a patent application.31 This is challenging because claims can be amended, deleted, or added during prosecution of the patent application into a patent. Therefore, a final inventorship determination should be made when allowable claims are identified. It is useful to note that because there are often multiple claims with multiple elements, it is possible for a joint inventor to contribute to only a single claimed feature, or to a feature recited in only a single claim. However, if that feature or claim is cancelled from the claims of the application, the contributor of that feature should be deleted from the list of named inventors. The first step in assessing (or reassessing) inventorship is to construe the claims (i.e., determine what the invention is), and then compare the contributions of asserted inventors or co-inventors with the claimed subject matter.32 This means that it is useful to keep a record of the contributions of various individuals involved in the development process. If, in the course of prosecution of the patent application, all claims that reflect the contribution of one inventor are cancelled or rejected, that inventor’s name must be removed.

In any case, joint inventorship can only occur where there has been some communication between the joint inventors, and where the contributions of each are embodied in the claimed invention (including how to make a claimed product). It is unnecessary that inventors work together, that they make equal contributions, that they each contribute to the subject matter of every claim, or that they conceive their contributions at the same time—although two inventors who are unaware of each other’s conceptions are sole, rather than joint, inventors.

IV. Authorship is not Inventorship

Sometimes an invention is described in a scholarly or scientific publication as well as in a patent application. The group of individuals who may appropriately be named as authors of the publication and the inventors who may be properly named in the patent application may sometimes overlap, but are not necessarily identical. This is true because the standard for inventorship is different than the standard for selecting authors for an article.33 A researcher might list as co-authors colleagues who made their labs and equipment available, discussed and helped evaluate data, performed some of the experiments, or helped draft the paper for publication. However, these individuals would be co-inventors of the invention only if they contributed to its conception. Moreover, while co-authors may choose not to be named on a paper, U.S. patent laws require that every person who contributes any part of what is claimed in a patent application must be named as an inventor.

There is an implicit lack of equality in co-authorship. Generally, the first or last listed author is considered to be primary originator of the new ideas and data in the paper, and the others are assumed to be secondary collaborators. Joint inventors, however, have equal rights to their patent

31 Ethicon, Inc. v. U.S. Surgical Corp., 135 F.3d 1456, 1460 (Fed. Cir. 1998).32 See id. at 1461-62.33 See, e.g., MPEP § 716.10 (“[t]he designation of authorship or inventorship does not raise a presumption of inventorship with respect to the

subject matter disclosed in the article or with respect to the subject matter disclosed but not claimed in the patent or published application so as to justify a rejection under 35 U.S.C. § 102(f).”)

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unless they agree otherwise.34 Even though they did not conceive exactly the same idea together, or each created a different part of the whole invention, or the contribution of one was only a small but essential part of the invention, all are joint inventors and, absent an agreement to the contrary, share an equal right to exclude others from making, using, or selling the claimed invention without accounting to the other inventors.35

In contrast to scientific publications, the order of inventors listed on a patent is irrelevant. By convention, the surname of the first inventor is printed at the top of the patent cover sheet and some members of the patent community or courts refer to the patent by that name. Others tend to use the name of the assignee or the last three digits of the patent number. Therefore, if there is a desire to refer collectively to a grouping of patents having at least one inventor in common, it might be useful to list the name of that inventor first. On the other hand, if it is important for an organization to recognize each inventor individually from a group of inventors named on several patents or to distinguish the patents from each other, then it would be advantageous to rotate the order of those named first on the patent.

V. Management is not Inventorship

There is sometimes a tendency in corporate research settings to consider individuals only tangentially involved with a research project to be an inventor of the inventions that result from that project. This tendency appears to increase in proportion to the particular individual’s status in the corporation or the financial rewards or incentives offered by the corporation in connection with being named as an inventor of a patented invention. That an individual is involved in the management or funding of a research project does not make that individual an inventor if the individual did not contribute to the conception of the invention claimed in the patent application, as discussed above. In other words, a supervisor or team leader should not automatically be named as an inventor without first identifying his or her contribution to the conception of the invention. In evaluating whether a particular individual should be named as inventor, the detrimental effect on the validity of the patent that results from errors in inventorship should always be kept in mind.

VI. Correction of Inventorship

Despite the best efforts of those involved in the patent application preparation process to name the proper inventors, times may exist when the initial determination of inventorship is incorrect. Errors in inventorship may be corrected in a number of ways, which can be categorized according to when the error is discovered and the correction attempted. As a general rule, inventorship should be corrected as soon as an error is discovered.36 It is usually the case that the earlier the error is discovered, the easier it is to correct. In almost all situations, however, it will be necessary to establish that the error in inventorship occurred without deceptive intent.37

34 See 35 U.S.C. § 262 (2000).35 See id.36 See mpep § 201.03 (“Although 37 CFR 1.48 does not contain a diligence requirement for filing the request, once an inventorship error is

discovered, timeliness requirements under 37 CFR 1.116 and 37 CFR 1.312 apply.”).37 See Pannu v. Iolab Corp., 155 F.3d 1344, 1350 (Fed. Cir. 1998).

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For example, errors in inventorship discovered during prosecution of a patent application may be corrected by filing a petition to correct inventorship.38 This petition must be accompanied by (1) a statement from each person being added as an inventor and each person being deleted as an inventor that the error in inventorship occurred without deceptive intent on his or her part; (2) a new oath or declaration signed by the actual inventors; (3) the consent of any assignee(s) to the change; and (4) a petition fee.39

Less stringent requirements apply for correcting inventorship when the originally named inventors were correct, but the prosecution of the application has resulted in the cancellation of all claims to which one or more of the inventors contributed.40 These inventors can be deleted by filing a petition acknowledging that the deleted inventor’s invention is no longer being claimed and paying a petition fee.41

The procedural requirements of petitioning to correct inventorship can be avoided, provided that at least one true inventor was originally named when the application was filed. In this situation, a “continuation” application naming the correct inventors can be filed.42 This requires a new oath or declaration by the correct inventors, but does not require a petition or statement from the inventors. Filing a continuation may cause the loss of patent term in certain cases, however, and the new application fee charged by the United States Patent and Trademark Office is higher than the fee for filing a petition.

A patent that issues with incorrect inventorship is invalid.43 A defective patent omitting one or more inventors can be corrected to add the omitted inventors in the absence of deceptive intent by the applicant.44 Misjoinder of an inventor (i.e., when a patent incorrectly lists a person as an inventor) can be corrected regardless of intent.45 The originally named inventors and assignees can file a petition to the Commissioner of Patents and Trademarks to issue a certificate naming the correct inventors.46 All originally named inventors and representatives of each assignee must submit statements agreeing to the change of inventorship in the patent. Each person being added as an inventor must state that the inventorship error occurred without deceptive intent on his or her part. In situations where the inventorship issue is contested or all parties are not in agreement, and where an issued patent is assigned to one or more entities, the assignee(s) of the entire interest of the patent may file a reissue application to correct inventorship without the original inventor’s consent.47

38 Note that evidence of incorrect inventorship—such as an admission by an applicant presented in a failed request to correct inventorship under 37 C.F.R. § 1.48(a)—can serve as a basis for a rejection of claims of an application under 35 U.S.C. § 102(f). See MPEP § 2137.01.

39 See 35 U.S.C. § 116 (2000); 37 C.F.R. § 1.48(a) (2008).40 37 C.F.R. § 1.48(b) (2008).41 Id.42 Id. § 1.53(b)(1)(2).43 See 35 U.S.C. § 256 (2000).44 See id.; Pannu, 155 F.3d at 1350. If deceptive intent is found, a court can also render the patent unenforceable due to inequitable conduct.

See PerSeptive Biosys., Inc. v. Pharmacia Biotech, Inc., 225 F.3d 1315 (Fed. Cir. 2000). 45 See Stark v. Advanced Magnetics, Inc., 119 F.3d 1551, 1555 (Fed. Cir. 1997) (“[S]ection 256 allows deletion of a misjoined inventor

whether that error occurred by deception or by innocent mistake.”).46 See 35 U.S.C. § 256 (2000); 37 C.F.R. § 1.324 (2008).47 See MPEP § 1412.04.

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If the error is discovered during litigation, the patent is not automatically declared invalid.48 Instead, if the court is satisfied that the error occurred without deceptive intent by the applicant, it can order the Commissioner of Patents to issue the certificate of correction.49

VII. Summary of Rules for Identification of Inventors

The definition of “joint inventor,” especially in the university setting, was clearly summarized in Monsanto Co. v. Kamp:50

A joint invention is the product of collaboration of the inventive endeavors of two or more persons working toward the same end and producing an invention by their aggregate effort . . . [I]t is necessary that each of the inventors work on the same subject matter and make some contribution to the inventive thought and to the final result. Each needs to perform but a part of the task if an invention emerges from all of the steps taken together. It is not necessary that the entire inventive concept should occur to each of the joint inventors, or that the two should physically work on the project together. One may take a step at one time, the other an approach at different times.

One may do more of the experimental work while the other makes suggestions from time to time. The fact that each of the inventors plays a different role and that the contribution of one may not be as great as that of another, does not detract from the fact that the invention is joint, if each makes some original contribution, though partial, to the final solution of the problem.

In summary, one should ask the following questions to identify whether the individual participated in conception of the invention. If the answer to any question is “yes,” the individual is an inventor and should be listed on the patent application.

(1) Did the individual form in his or her mind a definite and permanent idea of the com-plete and operative invention such that someone else, skilled in the same area, would be enabled by the idea to perform the method or make the product under the direction of the individual without extensive research or experimentation?

(2) Did the individual conceive a part of the invention as it is described and claimed in the application?

(3) Did the individual, independently and not under the direction of another, design exper-iments or resolve a problem that made the whole invention or some part of it operable?

(4) Did the individual take the idea of another and add new and independent alterations that became part of the invention as claimed in the patent application?

(5) Did the individual advise another inventor on how to improve the basic inventive concept by modification or addition such that the advice was incorporated into the invention as claimed in the patent application?

48 See, e.g., C.R. Bard, Inc. v. M3 Sys., Inc., 157 F.3d 1340 (Fed. Cir. 1998).49 See 35 U.S.C. § 256.50 269 F. Supp. 818, 824 (D.D.C. 1967).

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(6) Did the individual’s independent mental processes result in a contribution, such as new experimental designs, that resolved a problem in the basic inventive concept and made it operable or useful?

(7) Did the individual, during the course of experimentation, make an unexpected discov-ery and recognize the discovery as new and useful?

Practically speaking, the key questions on which inventorship turn are whether the individual in question modified, contributed, or added to the basic inventive concept and whether this contribution was communicated to the other inventor or joint inventors. If the contribution by an individual, which was the result of his or her own independent mental activity, could be deleted from the application without changing the invention as claimed, that individual is not a joint inventor.

KILPATRICK STOCKTON

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

TRADEMARK & COPYRIGHT

Likelihood of Confusion Surveys

Jerre B. Swann, William H. Brewster, J. David Mayberry, and R. Charles Henn, Jr.

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Likelihood of Confusion SurveysJerre B. Swann, William H. Brewster, J. David Mayberry, and R. Charles Henn, Jr.

I. Introduction

In the 2006 Kilpatrick Stockton Desk Reference Book, we covered surveys generally.1 The majority of surveys under the Lanham Act address likelihood of confusion,2 and the predominant formats, from the onset, have been Eveready and Squirt.3 These formats differ dramatically in: (a) their opening questions; (b) the means by which they replicate market reality, access brands, and facilitate inferences as to source; (c) the confusion factors they measure; and (d) the circumstances under which they may provide evidence supporting (or negating) a conclusion as to a likelihood of confusion. This article focuses exclusively on the Eveready and Squirt formats.

In 1976, in Union Carbide Corp. v. Ever-Ready, Inc.,4 the Seventh Circuit endorsed Eveready in litigation involving the EVEREADY mark for batteries. Over time, it has become the gold standard5 in cases where the senior mark is strong, i.e., highly accessible in memory,6 enhancing the likelihood that it will be cognitively cued by a junior user’s mark.

In 1980, in Squirtco v. Seven-Up Co.,7 the Eighth Circuit held that results from a Squirt study supported a district court finding as to the “possibility of confusion” between SQUIRT and QUIRST for non-cola soft drinks. Over time, the Squirt format has come to be used in cases where accessibility of the senior mark in memory is low to non-existent, so that it must be made externally available to respondents as part of the survey design.

The analysis below confirms, as to strong marks, the gold standard status of the Eveready format. As to the Squirt format, this analysis explores two frailties: (a) the design uses closed-ended, “suggestive” questions;8 and (b) it may create an “artificial marketplace” for respondent assessments

1 See R. Charles Henn, Jr. & Lauren T. Estrin, An Introduction to Surveys in Trademark Litigation, KilpatricK StocKton intellectual property DeSK reference (2006).

2 See Gerald L. Ford, Lanham Act Surveys by Issue, in lanham act SurveyS annual cummulative upDate (2007), available in the members-only section of the International Trademark Association’s website, www.inta.org. Roughly calculated, 53% of the reported decisions dealing with types of survey issues (likelihood of confusion, genericism, secondary meaning, false advertising and fame/dilution) address likelihood of confusion.

3 An Eveready format is “unaided”: the respondent is shown only the allegedly infringing mark/dress, and the principal “source confusion” question is open-ended. A Squirt format is doubly “aided;” the respondent is shown both plaintiff’s and defendant’s marks/dresses, and the principal “source confusion” question is closed-ended. Of the decisions in the Annual Cumulative Update from 1998 through 2007, from which the format can be determined, approximately 40% involved Eveready designs and 35% Squirt designs.

4 531 F.2d 366, 385–88 (7th Cir. 1976).5 See, e.g., 6 J. thomaS mccarthy, mccarthy on traDemarKS & unfair competition § 32:175 (4th ed. 2008). 6 The line between strong and weak marks, i.e., the degree to which they are internally available, is neither bright nor constant. The firm,

in past years, used a Squirt format in connection with marks that it now tests with an Eveready format, and the accessibility of a brand in memory occasionally can only be determined by a pilot study.

7 628 F.2d 1086, 1089 n.4, 1091 (8th Cir. 1980). 8 See, e.g., R. Bradlee Boal, Techniques for Ascertaining Likelihood of Confusion and the Meaning of Advertising Communications,

73 traDemarK rep. 405, 422 (1983) (the Squirt format’s same-company/different-company question is not neutral, but “suggest[s] a possibility that might not have occurred to the interviewees—that the products are made by the same company”); Shari S. Diamond, Reference Guide on Survey Research, in reference manual on Scientific eviDence 251, 252 (2000) (“Closed-ended questions . . . may remind respondents of options that they would not otherwise consider . . . .”). “[T]he mere putting of [the] question [can create] the impression of a relationship.” Kargo Global, Inc. v. Advance Magazine Publishers, Inc., No. 06 Civ. 550 (JFK), 2007 U.S. Dist. LEXIS 57320, at *25 (S.D.N.Y. Aug. 6, 2007).

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of brand similarity.9 Thus, a Squirt survey must include a robust control, and must be limited to the conditions of its origin (directly competing or substantially overlapping goods) where the stimuli proximately tested in the format do appear, in fact, proximately in the marketplace.

A. Eveready

1. The Questionnaire and Variants

In an Eveready survey, a respondent is first shown an exemplar,10 photograph,11 or advertisement of defendant’s branded (or “trade dressed”) product; then, the respondent is asked an open-ended12 “source confusion” question: “Who makes or puts out _______?” That question is followed by: “Why do you say that?”13 Questions as to “sponsorship confusion” and “affiliation confusion,”14 often in closed-ended form, typically follow, e.g.:15

Do you believe that whoever makes or puts out ______: ONE, is sponsored or approved by another company; TWO, is not sponsored or approved by any other company; or THREE,

9 Kargo Global, 2007 U.S. Dist. LEXIS 57320, at *24.10 Context can convey information that consumers use in making source determinations. With point of purchase surveys, therefore, “the

closer the survey context comes to marketplace conditions, the greater the evidentiary weight it has,” which often requires displaying actual products, packaging and other source indicia that consumers would encounter at the point of sale. mccarthy, supra note 5, § 32:163.

11 With post sale confusion, context (adjacent competitive products, etc.) is irrelevant and would give the respondent information not typically available in a post sale encounter. See Gateway, Inc. v. Companion Prods., Inc., 68 U.S.P.Q.2d 1407, 1420 (D.S.D. 2003) (“Post-sale confusion is particularly relevant in this case because . . . [a]fter Cody Cow is purchased, the point of sale materials are removed by the purchaser, and [have] no ‘confusion obviating effect’”), aff’d, 384 F.3d 503 (8th Cir. 2004). Accordingly, photographs or videos that fairly reproduce what a respondent would see in a post sale environment are easier to control (and afford greater certainty as to what respondents see) than actual displays that a field service may not faithfully execute in a shopping center interviewing booth. See Hermes Int’l v. Lederer de Paris Fifth Ave. Inc., 50 F. Supp. 2d 212, 222 (S.D.N.Y. 1999), aff’d in part, rev’d in part, 219 F.3d 104 (2d Cir. 2000), approving a post sale stimulus showing a “Kelly bag (as carried by a woman walking at a distance of four feet).”

12 Open-ended questions “require the respondent to . . . express an answer in his or her own words [and] give the respondent fewer hints about the answer that is expected or preferred.” Diamond, supra note 8, at 251–52.

13 With the advent of experimental designs, and the acknowledged difficulty that consumers can have in expressing “higher order processes,” Richard E. Nisbett & Timothy DeCamp Wilson, Telling More than We Can Know; Verbal Reports on Mental Processes, 84 pSychological rev. 231 (1977), Dr. Diamond is of the opinion that “why” questions may no longer be necessary. Courts, however, often like to play with the “clarifying” information that “why” questions produce, Cumberland Packing Corp. v. Monsanto Co., 32 F. Supp. 2d 561, 572–73, 576 (E.D.N.Y. 1999); some courts reject studies without “why” questions, Pep Boys Manny, Moe & Jack of Cal. v. Goodyear Tire & Rubber Co., No. 01-CV-5614, 2002 U.S. Dist. LEXIS 5925, at *30–33 (E.D. Pa. April 5, 2002); and information developed from “why” questions may be helpful to counsel in analyzing both consumer perceptions and the efficacy of the control stimulus, 24 Hour Fitness USA, Inc. v. 24/7 Tribeca Fitness, LLC, 447 F. Supp. 2d 266, 280–81 (S.D.N.Y. 2006), aff’d, 247 F. App’x 232 (2d Cir. 2007).

14 Section 43(a) of the Lanham Act proscribes conduct that is likely to cause confusion “as to affiliation, connection or association . . . or as to origin, sponsorship or approval . . . .”

15 See, e.g., Starbucks U.S. Brands, LLC v. Ruben, No. 91156879, 2006 T.T.A.B. LEXIS 54, at *35–37 (T.T.A.B. Feb. 9, 2006).

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you don’t know or have no opinion? 16 [If ONE] What other company? [and] Why do you say that? 17

The basic format has been approved so often that material variants are infrequent.18

The follow-on questions, of course, may be phrased in a more open-ended fashion19 and, under particular circumstances, a follow-on question may become the lead inquiry.20 Radical alterations, however, often suggest a departure from the requirement that a design be objective: e.g., the question “based on what you just saw, do you or don’t you know who or what brand or company makes or puts out ________,” followed by an “admonishment” to respondents to answer only if they “knew the correct answer,” was rejected as “tortured” and calculated to “produce a low response rate.”21

Nonetheless, variant approaches, one of them stemming from Union Carbide itself, do exist, both in the case law and the literature:

(1) Where the owner of the senior mark is substantially anonymous and the defendant’s goods are in a different category, the respondent is asked: “Please name any other products put out by the same concern which puts out . . . .”22

16 “[P]resentation of an explicit ‘don’t know’ or ‘no opinion’ alternative commonly leads to a 20%-25% increase in the proportion selecting that response,” Diamond, supra note 8, at 250, and a number of courts insist on “don’t know” alternatives. See, e.g., Cumberland Packing Corp., 32 F. Supp. 2d at 572; Procter & Gamble Pharms., Inc. v. Hoffmann-La Roche Inc., No. 06 Civ. 0034 (PAC), 2006 WL 2588002, at *22–25 (S.D.N.Y. Sept. 6, 2006). Choices in closed-ended questions must “cover all possible answers a respondent might give to the question [including “don’t know]. If the list . . . is incomplete, a respondent may be forced to choose one that does not express his or her opinion.” Diamond, supra note 8, at 253, citing Am. Home Prods. Corp. v. Johnson & Johnson, 654 F. Supp. 568, 581 (S.D.N.Y. 1987).

17 In Eveready designs, follow-ons are generally considered as the “standard type and format of questions used to gauge confusion . . . .” Pharmacia Corp. v. Alcon Labs., Inc., 201 F. Supp. 2d 335, 365 (D.N.J. 2002). Failure by a defendant, seeking to disprove a likelihood of confusion, to test for “sponsorship or affiliation” may lead to the rejection of its study. Bear U.S.A., Inc. v. Kim, 71 F. Supp. 2d 237, 252 n.106 (S.D.N.Y. 1999), aff’d, 216 F.3d 1071 (2d Cir. 2000). With Squirt designs, some courts have expressed concern with the cumulative impact of a series of closed-ended questions as to “same company,” “affiliated company,” and/or “sponsorship.” See U.S. West, Inc. v. Hatten Commc’ns Holding Co., No. 110, 126, 2002 T.T.A.B. LEXIS 620, at *15–20 (T.T.A.B. Sept. 25, 2002) (unpublished) (“we have accorded no weight to opposer’s survey. Not only are the questions memory based [the stimulus was removed from respondents’ view before the questionnaire was administered], but in addition, a respondent merely had to give a ‘wrong’ answer to one of the pertinent [three] questions in order to be counted as part of the 22.9% of the respondents who were ‘confused.’”). The “wrong answer” concern is alleviated in Eveready designs where respondents are usually required to identify the “other company,” and I am unaware of any instance where a makes/sponsors/affiliated trilogy in an Eveready test has engendered the strong demand effects that can surface in a Squirt design. See, e.g., Kargo Global, 2007 U.S. Dist. LEXIS 57320, at *17, where 80% of respondents in both the test and the control gave answers reflecting confusion to a closed-ended trilogy.

18 The most bizarre is reported in Arche, Inc. v. Azaleia, U.S.A., 882 F. Supp. 334, 335 (S.D.N.Y. 1995): Plaintiff’s counsel designed a questionnaire and sent one of their employees, . . . a part-time typist, drama student and

actress, into Washington Square Park, which is located within blocks of one of plaintiff’s retail stores. Over a two day period, she approached a number of people who, she said, looked as if they could afford plaintiff’s shoes, which sell at prices considerably higher than defendants’ . . . . [S]hod in defendants’ shoes, [she] asked the well-to-do passersby whether they could identify the shoes she was wearing.

19 For example, in James Burrough Ltd. v. Sign of Beefeater, 540 F.2d 266, 278 (7th Cir. 1976), a precursor to Union Carbide, the sponsorship question was: “Who do you believe is sponsoring or promoting this restaurant?”

20 Id.21 McNeil-PPC, Inc. v. Merisant Co., No. 04-1090 (JAG), 2004 WL 3316380, at *20 (D.P.R. July 29, 2004) (defendant’s expert “testified that

in formulating this question, he was guided by the survey . . . in Eveready . . . . The actual question asked in Eveready was much simpler . . . . The differences . . . are material, and likely affected the responses.”).

22 Union Carbide Corp., 531 F.2d at 385 n.11. Only 0.6% of respondents identified Union Carbide as the maker of defendant’s Ever-Ready lamp; 54.6% answered, however, that the same concern that put out Ever-Ready lamps also put out batteries, supporting a finding of likelihood of confusion and secondary meaning of EVEREADY as well. Id. at 381.

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(2) Separately, or in a follow-on, respondents may be tested as to an alternative form of “sponsorship confusion:” whether “the company that puts ______ out” “needed to get” or “did get” permission from another company and, if yes, from whom.23

(3) Where consumers shop “for frequently bought household goods . . ., they make quick decisions based on the ‘gestalt’ of the product.”24 To replicate this phenomenon: (i) respondents may be shown a notebook with several pages reflecting such brands grouped in different product categories (one of which categories will include the al-legedly infringing junior brand); (ii) they will then be asked to list the brands they recall having seen; and (iii) their measure of “confusion” will be the percentage of respondents reporting having seen the senior brand.25

2. Categorization and Pattern Matching in an Eveready Format

To appreciate fully the benefits of an Eveready approach and variants, it is first necessary to understand current conditions of clutter. Half a century ago, Ralph S. Brown, Jr. wrote that there was a “babel of brands,”26 and the “number of choices has [since] grown dramatically.”27 Consumers are bombarded by brand stimuli and cannot “attend” to all that fall within the range of their senses.28 Of necessity, they “are highly selective.”29

23 See, e.g., Cairns v. Franklin Mint Co., 107 F. Supp. 2d 1212, 1219 (C.D. Cal. 2000), aff’d, 292 F.3d 1139 (9th Cir. 2002). In a Squirt survey, the alternative is “aided:” e.g., did A need to get/get permission from B? Critics of “needed to get” wording insist it calls for a legal conclusion. Nat’l Football League Props., Inc. v. Prostyle, Inc., 57 F. Supp. 2d 665 (E.D. Wis. 1999). Critics of “did get” wording insist that a respondent can have no way of knowing whether or not permission was obtained. Jacob Jacoby, Sense and Nonsense in Measuring Sponsorship Confusion, 24 carDozo artS & ent. l.J. 63 (2006). As noted elsewhere, we regard the debate largely as a waste of judicial resources. Jerre B. Swann, U.S. Trademark Surveys, in Survey eviDence anD the law worlDwiDe 333–34 (Lexis Nexis 2008). See Pebble Beach Co. v. Tour 18 I Ltd., 155 F.3d 526, 544 (5th Cir. 1998).

24 hanS zeiSel & DaviD h. Kaye, prove it with figureS: empirical methoDS in law anD litigation 158 (1977). For how long a respondent should be exposed to a stimulus is a function of consumer involvement in the purchase. Hurried consumers, for example, do not typically study items, and stimuli reflecting such items should not be left with the respondent during the administration of a questionnaire. See Am. Home Prods. Corp. v. Procter & Gamble Co., 871 F. Supp. 739, 748 (D.N.J. 1994) (“consumers do not normally meditate . . . over . . . details for any appreciable length of time”). With respect to many items, however, consumers can be expected to study packages, and a stimulus should be left with a respondent. See Cumberland Packing Corp. v. Monsanto Co., 32 F. Supp. 2d 561, 578 (E.D.N.Y. 1999) (“In an actual market situation, the product would not disappear from the consumer’s eye just as he or she is about to make a purchase.”). See generally Jerre B. Swann, A ‘Reading’ Test or a ‘Memory’ Test: Which Survey Methodology Is Correct?, 95 traDemarK rep. 876 (2005), and Mike Rappeport, Response to Survey Methodology Articles, 96 traDemarK rep. 769 (2006) (advocating the more conservative view that the stimulus, in most circumstances, be left with the respondent). See also Henry D. Ostberg, A Response to an article entitled: A “Reading” Test or a “Memory” Test: Which Survey Methodolgy Is Correct? 95 traDemarK rep. 1446 (2005) (advocating the opposite).

25 zeiSel & Kaye, supra note 24, at 158–59 (it should be noted that Dr. Zeisel’s approach, for point of sale confusion purposes, may be inappropriate where the junior and senior brands are typically shelved adjacent to one another so that respondents should have the context of the senior brand to make judgments as to the junior, Winner Int’l LLC v. Omori Enters., Inc., 60 F. Supp. 2d 62, 71 (E.D.N.Y. 1999)).

26 Ralph S. Brown, Advertising and the Public Interest: Legal Protection of Trade Symbols, 57 yale l.J. 1165, 1197 (1948). 27 AMA Marketing Management: Spring 2000. 28 Jacob Jacoby, The Psychological Foundations of Trademark Law: Secondary Meaning, Genericism, Fame, Confusion and Dilution, 91

traDemarK rep. 1013, 1022 (2001) (“the vast majority of stimuli fail to register upon the consumer’s consciousness”); wayne D. hoyer & Deborah J. macinniS, conSumer behavior 115 (3d ed. 2004) (“Shoppers in a supermarket are exposed to numerous products, brands, ads, displays, signs, prices, logos, and packages all at the same time. We are generally unable to examine all those marketing stimuli simultaneously.”).

29 philip Kotler & Kevin lane Keller, marKeting management 186 (12th ed. 2006) (“It has been estimated that the average person may be exposed to over 1,500 ads or brand communications a day. Because a person cannot possibly attend to all these, most stimuli will be screened out . . . .”). See Toro Co. v. ToroHead, Inc., 61 U.S.P.Q.2d 1164, 1180 (T.T.A.B. 2001) (“Every day consumers are bombarded with hundreds, if not thousands, of advertisements for hundreds of products . . . . A great many of these ads do not make a significant impression on the public . . . .”).

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Even when a stimulus registers on their consciousness, consumers “rarely . . . consider all [its] features;”30 rather, given their attention constraints amid clutter, they use shortcuts to “label, identify, and classify” the information.31 If, for example, they see a small creature with the salient features of feathers and wings, they “categorize” it as a bird without stopping to test for all avian characteristics.32

In memory,33 strong brands function, in part, as antidotes to clutter; they exist as schemas–as “clusters”34 of information: (a) with source identifying (reputational) nodes at their center; (b) very strongly linked to the product(s) or service(s) in connection with which they are used; and (c) also linked to (usually a host of) other associations that have been engrafted on the schema by advertising, word of mouth or experience.35 Cognitively, “[a] unique brand name and cohesive brand identity are probably the most powerful pieces of information for consumers . . ., enabling [them] to efficiently organize, store, and retrieve information from memory.”36 Strong brands operate, moreover, much in the manner of the picture of a celebrity on the cover of a magazine in a sidewalk kiosk – they attract attention in an otherwise hurried environment.37

The adidas schema,38 as an example, has the brands (e.g., adidas, three stripes) and other indicia (e.g., shell toe, Superstar design) at its core strongly linked to athletic shoes and wear; they are also linked to a perception of high quality, soccer, sponsorship of the Olympics, and the like. When presented with a post-sale photograph of an athletic shoe with four parallel stripes on the side and with a shell toe, and asked the question, “Who makes or puts [this] out,” respondents do not meticulously review each feature of the stimulus but engage in “pattern matching” with respect to its salient characteristics.39 Respondents search their memory and identify the stimulus “based on its similarity to what [they] already know”40 and “[w]hen stimulus information offers a sufficient match to a schema possessed by the perceiver, the schema is called up from memory and used . . . to guide inferences.”41 As to the four stripes/shell toe example, 40% of test cell respondents typically draw the inference that the stimulus is adidas.42

30 Jacoby, supra note 28, at 1035, 1037.31 hoyer & macinniS, supra note 28, at 115.32 Jerre B. Swann & Michael J. Tarr, Configuration Protection Harmonized, 94 traDemarK rep. 1182, 1192 (2004).33 Very little information can be held (and attended to) in active consciousness, referred to as “cognitive workspace” or “consciousness of

the moment;” most information is stored in memory where its accessibility ranges from the instantaneous to the “virtually unavailable.” Jacoby, supra note 28, at 1015–16.

34 Id. at 1024–25; Jerre B. Swann, An Interdisciplinary Approach to Brand Strength, 96 traDemarK rep. 943, 946 (2006). 35 For a discussion and a diagram of the Nike brand schema, see J. paul peter & Jerry c. olSon, conSumer behavior anD marKeting

Strategy 58–61, 74–81 (7th ed. 2005) (noting that a brand is a “bundle” of functional and psychosocial attributes). 36 Jacoby, supra note 28, at 1025; see hoyer & macinniS, supra note 28, at 183.37 peter & olSon, supra note 35, at 118–19.38 For purposes of full disclosure, we have appeared as counsel for adidas A.G. in numerous cases. 39 Jacoby, supra note 28, at 1035, 1037.40 hoyer & macinniS, supra note 28, at 102, 115–16 (3d ed. 2004) (“The cognitive networks in one’s memory . . . play a fundamental and

often decisive role in interpreting incoming information from the outside world.”).41 Donal E. Carlston & Eliot R. Smith, Principles of Mental Representation, in Social pSychology: hanDbooK of baSic principleS 196

(Guilford Press 2007).42 Expectation drives perception, JuDith lynne zaichowSKy, the pSychology behinD traDemarK infringement 74 (2006), and respondents

may overwrite features of a stimulus to conform to memory (e.g., they may convert four stripes to three). Swann, An Interdisciplinary Approach to Brand Strength, supra note 34, at 961–62.

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3. The Confusion Factors Tested by Eveready

The Eveready format thus primarily addresses three confusion factors: similarity of marks, similarity of products, and brand strength (accessibility in memory). Strength is the key: (i) if a schema is easily accessible, it can be cued by a similar mark even where there is little or no similarity in products;43 and (ii) if a brand is dominant (COKE), its schema may be cued by another brand in the category (PEPSI), even where there is no similarity of marks.44 If, however, the senior mark is not accessible, it obviously cannot be cued irrespective of mark and product similarity: when an “open-end question [is] used [in connection with] a mark that is not particularly well-known, it needs to be understood that the . . . “top-of-mind” awareness of the brand . . . required [by the Eveready format] may significantly underestimate [the likelihood of] confusion.”45

4. The Scope of Eveready

In cases involving strong marks, the Eveready format is the gold standard for fundamental cognitive and marketing reasons:

a. An Eveready survey (a) used among prospective consumers of the alleged infringer’s products or services; (b) in face-to-face interviews; and (c) with the stimulus left in view, engenders respondent “attention” approximating that of an “involved” consumer and thus produces, coupled with a control cell to filter market-share effects, a conservative (“reliable”) estimate of likelihood of confusion;46

b. Reviews of “why” question answers typically reveal that senior mark responses to a “who makes or puts out” question have occurred because: (a) “stored knowledge” of the senior mark is “accessible” in a respondent’s memory; and (b) there is a “fit between the stored knowledge and the [junior] stimulus.”47 Accordingly, an expert’s conclusion as to

43 An Eveready survey can thus measure the “reach” of a strong mark. “A mark that is strong . . . is more likely to be remembered and more likely to be associated in the public mind with [or triggered by] a greater breadth of products . . ., than is a mark that is weak because relatively unknown . . . .” James Burrough Ltd., 540 F.2d at 276.

44 William G. Barber discusses this phenomenon in a dilution context in How to Do a Trademark Dilution Survey (or Perhaps How Not to Do One), 89 traDemarK rep. 616 (1999). Control cells are thus necessary in any consumer survey as to strong marks. See Jerre B. Swann, Dilution Redefined for the Year 2002, 92 traDemarK rep. 585, 619–20 (2002).

45 phylliS J. welter, traDemarK SurveyS § 24.03[1][c] (1999). Welter postulates that the Eveready format requires “unaided awareness” of the senior brand. In our view, however, the format more closely resembles a partially aided awareness test: it assesses whether the junior user’s mark and product cues are similar enough to those of the senior brand to trigger the latter’s schema in response to a source confusion question.

46 Jerre B. Swann, Sophistication and the Sciences, 97 traDemarK rep. 1309 (2007). It is our view that net confusion from an Eveready of less than 10% should suffice to support a conclusion as to likelihood of confusion (and that, because of an elevated degree of noise discussed below, a net level above 10% should be required from a Squirt format). See mccarthy, supra note 5, § 32:189 (discussing a 10% threshold).

47 See E. Tory Higgins, Knowledge Activation: Accessibility, Applicability, and Salience, in Social pSychology: hanDbooK of baSic principleS 135 (Guilford Press 2007); Michel Tuan Pham & Gita V. Johar, Contingent Processes of Source Identification, 24 J. of conSumer reSearch 249, 250 (1997) (“The probability of source identification through cued retrieval depends essentially on [a.] the strength of the semantic link between the source and content that is formed at encoding, and [b.] the overlap between the cues that are available at retrieval, and the to-be-recollected material . . . .”). With ADIDAS, for example, most respondents give “stripes” in answer to a “why” question, reflecting their access to the three stripe mark and the “fit” or “overlap” with a stimulus that merely adds one stripe, or takes one stripe away.

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a “likelihood of confusion,” based on an appreciable percentage of senior mark responses, has cognitively sound underpinnings;48

c. Because a strong mark is likely to be attended to in the marketplace,49 it is reasonable to assume that a stimulus that “fits” the strong mark’s schema will be attended to, and that an Eveready survey thus measures probable assessments in the marketplace, not artificially created or forced opportunities; and

d. The only hypothetical is the degree to which a respondent would be likely to encounter the junior use in the marketplace, and any concern as to the real world basis for that likelihood is alleviated by limiting the universe to consumers and prospective consumers of goods in the category of the alleged infringer.50

With respect to strong marks, therefore, the Eveready format is a relevant, reliable, and objective test of likelihood of confusion. It satisfies critical Daubert criteria as interpreted in the 2000 advisory committee’s notes to Federal Rule of Evidence 702: it is a “tested,” not a subjective, approach; it has been peer reviewed; with a control cell, it has a known error rate; and it has been generally accepted in the scientific community.51

B. Squirt

As befits the current conditions of marketplace clutter, almost two million marks are federally registered. Comparatively few have (or can hope to develop) sufficiently strong memory traces so as to be cued by pattern matching engendered by a monadic exposure to a similar junior use. The internal search of memory for a strong brand’s schema that exists at the core of an Eveready study is thus hostile to the general run of marks; for weak marks, an Eveready format will consistently produce negligible estimates of likelihood of confusion. Ergo the Squirt format, with an external review of the marks at issue that flows from their side-by-side or sequential exposure inherent in the administration of a Squirt survey.52

48 See, e.g., Jacoby, supra note 28, at 1028, 1034. A junior use may only trigger association (dilution), rather than identification (confusion), and questions as to what a stimulus “brings to mind” are appropriately rejected for likelihood of confusion purposes. Holiday Inns, Inc. v. Holiday Out in Am., 481 F.2d 445, 447 (5th Cir. 1973). “Confusion and dilution [and fair competition] . . . exist on a continuum,” and a junior user’s position on the continuum is predominantly a function of (a) senior brand strength, (b) mark similarity, and (c) product similarity. Swann, Dilution Redefined for the Year 2002, supra note 44, at 620–21.

49 See Swann, An Interdisciplinary Approach to Brand Strength, supra note 34, at 955. “[F]amiliar brands are selectively given more exposure, attention, comprehension and retention by consumers,” Steve Hoeffler & Kevin Lane Keller, The Marketing Advantages of Strong Brands, 10 branD management 421, 424 (2003), and owners of strong brands thus get “dramatically more impact from the same communications budget.” DaviD a. aaKer, managing branD equity: capitalizing on the value of a branD name 186 (1991).

50 Such a universe definition is thus a “relevancy” requirement. See, e.g., Zimmerman v. Nat’l Ass’n of Realtors, No. 92032360, 2004 T.T.A.B. LEXIS 180 (T.T.A.B. Mar. 31, 2004). Likewise, where the junior user’s operations are geographically confined, the study should be confined to the area where there are respondents with the opportunity to come into contact with the junior mark. See, e.g., James Burrough Ltd., 540 F.2d at 277; Jacob Jacoby, Survey and Field Experimental Evidence, in the pSychology of eviDence anD trial proceDure 181 (Saul M. Kassin & Lawrence S. Wrightsman eds., 1985).

51 See feD. r. eviD. 702 advisory committee’s notes (2000).52 Where brands are externally available for comparison, an Eveready (with its requirement of internal accessibility) should not be used to

“disprove” confusion. Many courts, however, do not appreciate the distinction. See, e.g., Nat’l Distillers Prods. Co., LLC v. Refreshment Brands, Inc., 198 F. Supp. 2d 474, 482–84 (S.D.N.Y. 2002); GMA Accessories, Inc. v. Croscill, Inc., No. 06 Civ. 6236 (GEL), 2008 U.S. Dist. LEXIS 16052, at *27 (S.D.N.Y. Mar. 3, 2008).; Edge Wireless, LLC v. U.S. Cellular Corp., No. 03-1362-AA, 2004 U.S. Dist LEXIS 15297, at *17 (D. Or. July 23, 2004).

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1. The Questionnaire and Variants

In Squirtco,53 respondents first heard radio ads for SQUIRT and QUIRST and were then asked “Do you think SQUIRT and QUIRST are put out by the same company or by different companies?,” followed by “What makes you think that?” In current designs, questions as to “sponsorship confusion” and “affiliation confusion” follow.54

The number of Squirt variants is vast.55 In one, to remove a spotlight from the brands at issue, respondents are shown an array56 (including the senior and junior uses) and asked:

Do you think that each of these brands is from a separate company, or do you think that two or more are from the same company or are affiliated or connected [in any way]?57 If you don’t know, please feel free to say so.

[If TWO OR MORE FROM SAME COMPANY OR AFFILIATED/CONNECTED]

Which two or more brands do you believe are from the same company or are affiliated or connected? [and] Why do you say that? 58

Another variant, to address objections to a side-by-side or sequential display of brands not seen in such immediate proximity in the marketplace, is a “two room” study:59 (a) in the first room, the respondent sees a stimulus of the allegedly infringed product; (b) in the second room, the respondent sees a “line-up” of products in the same category, including the allegedly infringing product, and is asked whether any “come from the same maker or company as the product . . . I showed you [in the first room]?”60 The two-room study “is an attempt to replicate the marketplace process of advertising exposure to a brand or trade dress, followed by being confronted in the market with both similar and differing brands . . . .”61 Rather than rely on immediate juxtaposition of junior and senior

53 628 F.2d at 1089 n.4. 54 E.g., “Do you think the first ad you just heard: (a) comes from a company that has a business connection with the company that put out

the second ad you just heard; (b) comes from a company that does not have a business connection with the company that put out the second ad; or (c) you don’t know or have no opinion.” See Kargo Global, 2007 U.S. Dist. LEXIS 57320, at *14. As noted supra note 17, some courts have expressed concern with the cumulative impact of a series of closed-ended questions as to “same company,” “affiliated company,” and “authorization.”

55 See, e.g., Pilot Corp. of Am. v. Fisher-Price, Inc., 501 F. Supp. 2d 292 (D. Conn. 2007); Urban Outfitters, Inc. v. BCBG Max Azria Group, Inc., 511 F. Supp. 2d 482 (E.D. Pa. 2007); Ironclad, L.P. v. Poly-America, Inc., No. Civ. A. 3:98-CV-2600, 2000 U.S. Dist. LEXIS 10728 (N.D. Tex. July 28, 2000); and YKK Corp. v. Jungwoo Zipper Co., 213 F. Supp. 2d 1195 (C.D. Cal. 2002).

56 In T.T.A.B. proceedings, where marks are often tested in block letter form, OMS Invs., Inc. v. Cent. Garden & Pet Co., No. 91156249, 2006 T.T.A.B. LEXIS 274, at *40–41 (T.T.A.B. July 10, 2006), an array (that includes both the allegedly infringed and infringing marks) theoretically could be probative. Testing an array under marketplace conditions is substantially more problematic, see Westchester Media Co. v. PRL USA Holdings, Inc., 103 F. Supp. 2d 935 (S.D. Tex. 1999), aff’d in part, rev’d in part, 214 F.3d 456 (5th Cir. 2000), but may not be impossible—e.g., the brands in the array may all coexist on supermarket store shelves.

57 See Scott Fetzer Co. v. House of Vacuums, Inc., 381 F.3d 477, 488 (5th Cir. 2004) (criticizing the “in any way” phraseology as prodding “survey participants to search for any connection . . . .”).

58 This basic format, as to only three products, was used in Ecce Panis, Inc. v. Maple Leaf Foods USA, Inc., No. 07-1099-PHY-SRB, 2007 U.S. Dist. LEXIS 85780, at *16–17 (D. Ariz. Nov. 7, 2007), where, as can often occur with Squirt designs, the results of the (in treatment) control reduced the test results to a level below that supporting a conclusion as to likelihood of confusion.

59 See Storck USA v. Farley Candy Co., 797 F. Supp. 1399, 1408 (N.D. Ill. 1992). 60 mccarthy, supra note 5, § 32:177.61 Id.

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marks, it relies on a recent brand display (a “recency effect” in memory62) to make the allegedly infringed brand accessible.

2. Categorization and the Representativeness Heuristic

As noted above, consumers do not meticulously examine brand stimuli; they categorize based on salient characteristics, and one mechanism they use in interpreting and classifying stimuli is the representativeness heuristic. A heuristic is a mental short-cut that consumers often take when making decisions, and according to the representativeness heuristic, consumers are likely to infer that things that are physically or conceptually similar or seem related must go or belong together.63 In Beneficial Corp. v. Beneficial Capital Corp.,64 the operation of the heuristic in a Squirt format was explained (in lay terms) as follows:

To the key question asked by the survey, “Do you think that there may or may not be a business connection between Beneficial Capital Corp. and the Beneficial Finance System Companies?” thirty-one percent of the respondents stated that such a connection was either definite or probable . . . . The survey establishes . . . that the names are similar . . . and that portions of the general public will make the reasonable assumption that . . . two companies with similar names are likely to have a business connection.

In Wynn Oil Co. v. Thomas, the heuristic arguably was enshrined into law: “[c]ases where a defendant uses an identical mark on competitive goods . . . are ‘open and shut’ and do not involve protracted litigation to determine liability for trademark infringement.”65

3. The Confusion Factors Tested by Squirt

A Squirt survey and variants of the Squirt format test similarity of marks, similarity of products, and market proximity. The proximity factor is critical. In an Eveready survey, given the “accessibility” of a strong mark, an unaided comparison (involving an internal search of memory) is appropriate where the respondent is likely to encounter the junior mark (and pattern match) in the natural flow of commerce. In a Squirt format, however, where the senior mark is not “accessible” in memory, an aided comparison (involving the representativeness heuristic) is appropriate where the marks exist side-by-side in the market or if one is typically encountered sufficiently soon after the other that the recent brand or stimulus exposure (the “recency effect”) places both in the consumer’s “cognitive workspace.” A Squirt survey is based on an external review of two stimuli that must be

62 See hoyer & macinniS, supra note 28, at 185 (“[Y]ou are more likely to remember what you ate for breakfast this morning than what you ate a week ago because (1) this morning’s information has not yet decayed [been forgotten], and (2) there is much less information interfering with the retrieval of this information.”).

63 Daniel Kahneman et al., JuDgment unDer uncertainty: heuriSticS anD biaSeS 4 (1982) (“Many of the probabilistic questions with which people are concerned belong to one of the following types: . . . What is the probability that event A originates from process B? . . . In answering such questions, people typically rely on the representativeness heuristic, in which the probabilities are evaluated by the degree to which A resembles B. For example, when A is highly representative of B, the probability that A originates from B is judged to be high. On the other hand, if A is not similar to B, the probability that A originates from B is judged to be low.”).

64 529 F. Supp. 445, 450–51 (S.D.N.Y. 1982).65 839 F.2d 1183, 1191 (6th Cir. 1988) (quoting mccarthy, supra note 5, § 23:3). But see Vincent N. Palladino, Genericism Rationalized:

Another View, 90 traDemarK rep. 469, 478–79 (2000); zeiSel & Kaye, supra note 24, at 167–70 (negating the likelihood of confusion between “Workforce” for jeans sold in Gap and “Workforce” for socks sold in Sears). If the marks are weak and the products move through different channels of trade to different consumers, confusion may well be unlikely irrespective of mark and product identity.

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substantially proximate for the review, under “marketplace conditions,” to occur. Absent market proximity, respondents in a Squirt design are made “artificially aware” of the competing marks.66

4. The Scope of Squirt

The historical distaste for “suggestive” questions67 is likely to continue with respect to such questions that have a clearly “leading” effect68 or to a Squirt without a control cell. With, however, the advent of experimental designs, the judicial hostility toward all closed-ended questions should abate. As noted above, such questions are often used as follow-ons to “Who makes or puts this out?” in Eveready designs, and closed-ended questions are typically used to test “comprehension” in surveys in false advertising cases.69

More recently, in National Distillers Products Co., LLC v. Refreshment Brands, Inc.,70 the court rejected a two-room Squirt study with respect to goods in the same category (vodka versus a vodka cooler) because, absent display of the senior mark in the first room, “respondent[s] would almost certainly have been unfamiliar with . . . . [the allegedly infringed product] due to [its] very limited distribution network and weak sales.” That, however, is the reason for the existence of the format in the first place: without its insertion into consciousness, a weak mark cannot avail itself of consumer reaction evidence in a survey context.

Accordingly, many “closed-ended question” rejections and National Distillers are suspect law.71 The true limit on the design should derive from how the representativeness heuristic operates in a Squirt format—it facilitates inferences based on the similarity between the marks externally reviewed, either side-by-side or sequentially. A Squirt test should not be used, therefore, where the brands at issue do not proximately appear in the market. Under such circumstances, respondents who report a “connection” due to the “similarity of names” are “demonstrating merely that they had read the names . . . in artificially close proximity.”72

66 Kargo Global, 2007 U.S. Dist. LEXIS 57320, at *21–24 (“Kargo has offered no data or other evidence to support the proposition that prospective customers were likely to encounter Kargo’s trademark a short time after seeing Cargo magazine. . . . [I]t would [thus] have been far more replicative of actual market conditions to have displayed only Kargo’s materials and then asked the respondents open-ended questions regarding their beliefs about the source . . . . This is known as the ‘Eveready’ format.”). Because Kargo is weak, an Eveready test would likely produce zero evidence of likely confusion, but absent market proximity, only an Eveready reflects market reality. Where marks are weak and goods are not proximate, similarity assessments cannot occur either in the market or in the mind.

67 See Riviana Foods Inc. v. Societe Des Produits Nestle S.A., 33 U.S.P.Q.2d 1669, 1671 (S.D. Tex. 1994) (“Do you think the weight loss product ‘Sweet Success’ and ‘Success Rice’ are more likely made by the same company or more likely made by different companies?”). There are only six instances in the last ten years where a court had relied, even in part, on a Squirt survey in reaching a conclusion that there was a likelihood of confusion.

68 See Clicks Billiards Inc. v. Sixshooters Inc., 251 F.3d 1252, 1262 (9th Cir. 2001) (the question “Do you associate the visual look and appearance of this billiard parlor with Clicks Billiards only or with other billiard parlors too?” resulted in 80% Clicks responses).

69 See Proctor & Gamble v. Hoffmann-La Roche, No. 06 Civ. 0034(PAC), 2006 WL 2588002, at *22 (S.D.N.Y. 2006) (“The open-ended format is well suited for surveys focusing on simple and/or primary claims made in ads. On the other hand, open-ended questions are likely to understate secondary claims, particularly where those claims are rather complex by virtue of being both compound and comparative.”) (internal citation omitted). As Dr. Jacoby notes, “[r]eadily accessible stored information may be retrieved via open-ended (unaided recall) questions. However, retrieving less readily accessible stored information [as in a Squirt] generally requires using either ‘focused’ open-ended (aided recall) questions or closed-ended (recognition) questions.” Jacoby, supra note 28, at 1016 n.8.

70 198 F. Supp. 2d 474, 482–84 (S.D.N.Y. 2002). 71 Because the study in National Distillers had other flaws (the universe included potential purchasers of the allegedly infringed, not

infringing product), the rejection of the study was correct. The court also noted that “the liquor and cooler markets are not coextensive” so there may have existed proximity concerns as well. Id. at 484.

72 See Kargo Global, 2007 U.S. Dist LEXIS, at *26.

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A weak mark should not be placed in “recent” memory/“cognitive workspace” if it would not appear there under normal market conditions. To do so might be to give a weak mark artificial “reach” that it does not intrinsically possess. Quite simply, “in cases where the two parties’ products do not share the same market, the likelihood of confusion is reduced by the very fact that no consumer would ever be exposed to both products.”73 Accordingly, the above-noted rationale that a two-room study “replicate[s] the marketplace process of [an] advertising exposure to a brand or trade dress, followed by being confronted in the market with both similar and differing brands or trade dresses” should be the subject of proof, not postulation.74

Even where marks substantially and demonstrably overlap in the marketplace, we are still concerned as to whether they will be attended to, given that “the vast majority of stimuli fail to register upon the consumer’s consciousness.”75 Given the elevated “confusion” levels that Squirt studies produce, we are further troubled by a design that often reflects control cell “noise” of more than 25%.76 We nonetheless appreciate a two-pronged Squirt rationale: (a) for substantially overlapping marks, a Squirt has appreciable scientific underpinnings; and (b) it may be relevant to know, at minimum, whether two marks are sufficiently similar to one another so that, if they do “register,” they effectively will be considered the same.

II. Conclusion

Pattern matching (in the mind) and the representativeness heuristic (pattern matching in the external marketplace) suggest that for similar marks, particularly as applied to similar goods, some level of confusion is likely—consumers draw inferences from a “fit” between stimuli. The choice between Eveready and Squirt is dictated by where, as a matter of market reality, brand similarity assessments can take place.

The Eveready format is ideal for assessing whether, as to strong marks or as to marks that do not appear proximately or otherwise overlap in the marketplace, a likelihood of confusion is appreciable. As to such marks, an Eveready survey tests market reality—“what would be the confusion level if we were to allow introduction of the junior user’s mark given the current level of awareness of the senior user’s mark.”77

73 zeiSel & Kaye, supra note 24, at 167.74 See Leelanau Wine Cellars, Ltd. v. Black & Red, Inc., 452 F. Supp. 2d 772, 784 (W.D. Mich. 2006), aff’d, 502 F.3d 504 (6th Cir. 2007),

rejecting a two stage Squirt because there was “no indication that in the actual marketplace, purchasers of Chateau de Leelanau wine are ever exposed to LWC’s advertising shortly before they view or purchase [the] wine.” In a 1989 case, Dr. Zeisel was confronted with the result from a side-by-side Squirt study that 35% of respondents believed that “Workforce” for blue jeans sold by Gap were from the same company as “Workforce” socks sold in Sears stores. He then conducted two studies “to measure the likelihood that consumers would ever encounter both products” or would be aware “of the use of the mark on both products;” found that the likelihood ranged between .5% and 1%; and concluded that “the likelihood of consumer confusion was not 35%, but less than 1% among both Gap customers and the general population.” zeiSel & Kaye, supra note 24, 167–69.

75 Jacoby, supra note 28, at 1034.76 See, e.g., Pep Boys v. Goodyear, 2002 U.S. Dist. LEXIS 5925, at *30. We understand that there are natural error rates and subconscious

and subliminal influences on memory, hoyer & macinniS, supra note 28, at 97–98, 433, and that elevated noise may be just a byproduct of general marketplace clutter. See, e.g., Jacob Jacoby et al., am. aSS’n of aDvertiSing agencieS, miScomprehenSion of televiSeD communicationS (1980) (“the average amount of miscomprehension associated with any [televised] communication was an unexpectedly high 30%”). “Reliability” and elevated control cell noise are, however, disconnects.

77 Alex Simonson, Surveys of Trademark Confusion: Basic Differences, 5 intell. prop. StrategiSt 1, 2 (1998).

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The Squirt format is the alternative for testing the likelihood of confusion between marks that are weak, and cannot thus be compared unaided in the mind, but that substantially overlap or are simultaneously or sequentially accessible in the marketplace for comparison—so that their aided presentation is realistic, not artificial. It relies on the “proximity” factors in a likelihood of confusion analysis, rather than on the strength factor, as its market replication rationale.

That leaves, of course, a question as to how likelihood of confusion should be tested as to a weak mark that does not appear in proximity to a similar junior use. We know of no format for that purpose and, as may be gleaned from the foregoing, we consider it appropriate that none seems to exist. Compliant with a market replication mandate, there simply appears to be no way to test whether a weak mark will be confused with another’s use in a commercial arena where the weak mark does not appear and there is no customer overlap. Trademark law has long considered the relevance of geographic demarcations on a macro scale.78 With respect to choosing the appropriate format for a likelihood of confusion study, it may sometimes be necessary to engage in a micro analysis.

78 Dawn Donut Co. v. Hart’s Food Stores, Inc., 267 F.2d 358 (2d Cir. 1959).

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

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PATENT

Obviousness Doctrine Post-KSR: Friend or Foe?

Steven Gardner and Nicole N. Morris

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Obviousness Doctrine Post-KSR: Friend or Foe? Steven Gardner and Nicole N. Morris

I. Introduction

The Supreme Court’s opinion in KSR International Co. v. Teleflex Inc.1 (“KSR”) altered the standards applied by courts and the United States Patent and Trademark Office (“PTO”) in determining whether a patent is obvious in light of prior art. In the post-KSR world, where do you stand? Answer: it depends. If you are trying to procure a patent or enforce your patent rights, the KSR decision is not your friend. Since the Supreme Court announced a “flexible approach to obviousness,” obtaining a patent from the PTO or combating an assertion in litigation that a patent is invalid as obvious is likely to be more difficult. On the other hand, if you are trying to invalidate a patent, the KSR decision is your friend and provides new strength to the obviousness defense.

This article discusses the KSR decision, case law applying KSR, and practical implications for patent litigation and patent prosecution.

II. The KSR Decision

A patent claim claims obvious subject matter (and is invalid) “when the differences between the patent claims and the prior art are such that the claims would have been obvious at the time of the invention to one of ordinary skill in the art.”2 Prior to KSR, the Federal Circuit often employed the “teaching, suggestion, or motivation” (or “TSM”) test to resolve the question of obviousness.3 Under the TSM test, a patent claim is obvious only if “some motivation or suggestion to combine the prior art teachings” can be found in the prior art, the nature of the problem, or the knowledge of a person having ordinary skill in the art.4 In KSR, the Supreme Court explicitly rejected the Federal Circuit’s rigid application of the TSM test to determine whether an invention is obvious and therefore invalid. The Supreme Court held that the Federal Circuit’s approach was inconsistent with the Court’s prior decisions and § 103 of the Patent Act.5 The Court noted that its prior decisions set forth an “expansive and flexible approach” to the obviousness inquiry and invited courts, where appropriate, to look at secondary considerations that would prove instructive.6

The Supreme Court reversed the Federal Circuit’s finding of non-obviousness and identified four other errors in the Federal Circuit’s application of the TSM test. First, the Court found that the Federal Circuit erred in holding that “courts and patent examiners should look only to the problem the patentee was trying to solve.”7 Second, the Court found that the Federal Circuit should not assume that a person of ordinary skill attempting to solve a problem will be led only to those

1 KSR Int’l Co. v. Teleflex Inc., 550 U.S. 398 (2007).2 35 U.S.C. § 103(a) (2000).3 See KSR, 550 U.S. at 407.4 See Al-Site Corp. v. VSI Int’l Inc., 174 F.3d 1308, 1323-24 (Fed. Cir. 1999).5 KSR, 398 U.S. at 415.6 Id. 7 Id. at 420.

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elements of prior art designed to solve the same problem.8 Third, the Court held that the Federal Circuit erred in concluding that a patent claim cannot be proved obvious merely by showing that the combination of elements was “obvious to try.”9 Finally, the Supreme Court found that the Federal Circuit drew the wrong conclusion from the risk of falling prey to hindsight, and that the Federal Circuit established rigid rules that prevented the fact finder from using common sense.10

While the Supreme Court rejected the rigid application of the TSM test, the KSR decision did not eliminate the test as a rationale for finding obviousness. The Court stated, “[t]he obviousness analysis cannot be confined by a formalistic conception of the words teaching, suggestion, and motivation, or by overemphasis on the importance of published articles and the explicit content of issued patents.”11 Also, the Court stated that “it will be necessary for a court to look to interrelated teachings of multiple patents; the effects of demands known to the design community or present in the marketplace; and the background knowledge possessed by a person having ordinary skill in the art, all in order to determine whether there was an apparent reason to combine the known elements in the fashion claimed by the patent at issue.”12

The KSR decision contains a number of statements that other courts have since used in analyzing whether a patent is rendered obvious:

(1) “When a work is available in one field of endeavor, design incentives and other mar-ket forces can prompt variations of it, either in the same field or a different one. If a person of ordinary skill can implement a predictable variation, § 103 likely bars its patentability.”13

(2) “[I]f a technique has been used to improve one device, and a person of ordinary skill in the art would recognize that it would improve similar devices in the same way, using the technique is obvious unless its actual application is beyond his or her skill.”14

(3) If the claimed subject matter is merely a “simple substitution of one known element for another or the mere application of a known technique to a piece of prior art ready for improvement,” the invention is obvious.15

(4) “[W]hen a patent ‘simply arranges old elements with each performing the same func-tion it had been known to perform’ and yields no more than one would expect from such an arrangement, the combination is obvious.”16

(5) “When there is a design need or market pressure to solve a problem and there are a finite number of identified, predictable solutions, a person of ordinary skill has good reason to pursue these known options . . . If this leads to the anticipated success . . .

8 Id.9 Id. at 421.10 Id.11 Id. at 419. 12 Id. at 418.13 Id. at 417.14 Id.15 Id. 16 Id. (quoting Sakraida v. Ag Pro, Inc., 425 U.S. 273, 282 (1976)).

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the fact that a combination was obvious to try might show that it was obvious under § 103.”17

III. Practical Implications for Patent Litigators

The Federal Circuit has issued forty-three opinions that cite KSR.18 In 2008, the Federal Circuit reversed findings of nonobviousness five times, affirmed findings of nonobviousness eight times, and affirmed findings of obviousness three times. Post-KSR, the Federal Circuit seems to give greater weight to a prima facie case of obviousness than to objective evidence to nonobviousness. For instance, in Agrizap, Inc. v. Woodstream Corp.,19 the Federal Circuit held that the patent at issue, which involved a method and device for electrocuting pests, presented a “textbook case of when the asserted claims involves a combination of familiar elements according to known methods that does no more than yield predictable results.”20 Moreover, the Federal Circuit was not persuaded by the patentee’s secondary considerations of nonobviousness. The patentee offered objective evidence of nonobviousness, including commercial success, copying by the defendant, and a long felt need in the market for the invention.21 The court compared this case to its first post-KSR opinion, Leapfrog Enterprises, Inc. v. Fisher-Price Inc., where it invalidated a patent because it resulted from a combination of familiar elements that yielded predictable results, even though there were strong secondary considerations of commercial success and long felt need.22 In Leapfrog, the court ruled that “[a]ccommodating a prior art mechanical device that accomplishes that goal [of teaching a child to read phonetically] to modern electronics would have been reasonably obvious to one of ordinary skill in designing children’s learning devices.”23 As in Leapfrog, the Federal Circuit in Agrizap found that the combination of familiar elements yielding predictable results outweighed objective evidence of nonobviousness.

Likewise, in Muniauction, Inc. v. Thomson Corp., 24 the Federal Circuit found that the combination of known elements was quite similar to that in Leapfrog. The patent at issue in Muniauction involved municipal bond auctions. The court found that the broadly written claims made it difficult to use secondary factors of patentability to establish nonobviousness, specifically, the secondary evidence offered by Muniauction lacked the requisite nexus to the scope of the claims. “[C]ommercial success or other secondary considerations may presumptively be attributed to the patented invention only ‘where the marketed product embodies the claimed features, and is coextensive with them.’”25 Muniauction argued that an industry award it received and the subsequent press coverage of the award showed success of its products to rebut any prima facie showing of obviousness. The court

17 Id. at 421. 18 This figure is as of December 31, 2008 and includes appeals from the Board of Patent Appeals and Interferences. 19 520 F.3d 1337 (Fed. Cir. 2008).20 Id. at 1344. 21 Id.22 485 F.3d 1157 (Fed. Cir. 2007).23 Id. at 1161. 24 532 F.3d 1318 (Fed. Cir. 2008).25 Id. at 1328 (quoting Ormco Corp. v. Align Tech., Inc., 463 F.3d 1299 (Fed. Cir. 2006)).

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rejected Muniauction’s argument because the reports of success focused only on one portion of the invention as claimed. The Federal Circuit compared those narrow reports of success with the broad claims, finding that the success “lacks the required nexus with the scope of the claims.” 26

Since the KSR decision, the Federal Circuit has raised the bar on the requirement for objective evidence of nonobviousness. The court has invalidated a number of patents, ruling that the combination of familiar elements yielding predictable results outweighs any objective evidence of nonobviousness.27 Patentees seeking to rebut evidence of obviousness now should consider offering a significant amount of evidence supporting objective, secondary considerations and also should consider having such evidence introduced and described through adequate expert testimony.

A. Expert Testimony

Experts are key witnesses in patent cases. In the post-KSR era, expert testimony regarding the scope and content of the prior art may prove critical to a party’s success or failure regarding obviousness. First, make certain that your expert is a qualified technical expert. Testimony proffered by a witness lacking the relevant technical expertise fails to meet the standard of admissibility under the Federal Rules of Evidence.28 In a recent decision, the Federal Circuit held that a witness not qualified in the pertinent art may not testify as an expert on obviousness—or any of the underlying technical questions—such as the nature of the claimed invention, the scope and content of the prior art, the differences between the claimed invention and the prior art, or the motivations of one of ordinary skill in the art to combine these references to achieve the claimed invention.29 Additionally, the court found that the proffered expert, a patent attorney, was not qualified to testify on the issues of infringement and validity because he did not possesses the relevant technical expertise in the field of the invention.30 “Unless a patent lawyer is also a qualified technical expert, his testimony on these kinds of technical issues is improper and thus inadmissible.”31 An expert’s education and experience must be “sufficiently related to the subject matter of the [patent-in-suit] to allow him to speak with authority on the issues of validity and infringement.”32

Expert testimony is often critical evidence used to invalidate a patent for obviousness. A testifying expert often addresses whether there was or was not a motivation to combine or modify the prior art to arrive at the claimed invention. A testifying expert must generally be prepared to express an opinion about the knowledge of one of ordinary skill in the art. The Federal Circuit has suggested that it is important for an expert to opine on the limited number of ways to solve the problem

26 Id. 27 See CSIRO v. Buffalo Tech. USA, Inc., 542 F.3d 1363, 1377-78 (Fed. Cir. 2008) (vacating summary judgment of nonobviousness because

the secondary considerations did not justify the entry of summary judgment in light of the evidence bearing on obviousness); but see Erico Int’l Corp. v. Vutec Corp., 516 F.3d 1350, 1356 (Fed. Cir. 2008) (vacating a preliminary injunction because the defendant raised sufficiently “substantial question of invalidity to show that the claims at issue are vulnerable.”).

28 Fed. R. evid. 702.29 Sundance, Inc. v. Demonte Fabricating Ltd., 550 F.3d 1356, 1364 (Fed. Cir. 2008) (finding that “a witness not qualified in the pertinent

art may not testify as an expert as to anticipation, or any of the underlying questions . . . .”).30 Id. at 1362 (“Admitting testimony from a person such as Mr. Bliss, with no skill in the pertinent art, serves only to cause mischief and

confuse the factfinder.”).31 Id.32 Id. (quoting Cameo Indus., Inc. v. La. Cane Mfg., Inc., Civ. No. 92-3158, 1995 U.S. Dist. LEXIS 11294, at *10-11 (E.D. La. July 27,

1995)).

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addressed by the claimed invention.33 For example, in Ortho-McNeil Pharamceutical, Inc. v. Mylan Laboratories, Inc.,34 Ortho-McNeil filed an infringement action to prevent Mylan from producing a generic version of its epilepsy drug, topiramate. Citing KSR, Mylan argued that Ortho-McNeils’s discovery of the drug was obvious to try because there was a small, finite number of options that was available to a person of ordinary skill in the art.35 The Federal Circuit disagreed, finding that Mylan failed to demonstrate that a person of ordinary skill would have had some reason to select (among several unpredictable alternatives) the exact method that produced topiramate as an intermediate and would have stopped at that intermediate and test for properties unrelated to the purpose for which the drug was being created.36

In reaching its decision, the Federal Circuit criticized Mylan’s expert’s testimony. The court stated that Mylan’s expert simply retraced the path of the inventor with hindsight, discounted the number and complexity of the alternatives, and concluded that the invention of topiramate was obvious.37 The court found that the expert’s testimony failed to satisfy § 103 requiring an “analysis to examine ‘the subject matter as a whole’ to ascertain if it ‘would have been obvious at the time the invention was made.’”38 The opinion suggests that an expert must do more than retrace the steps of the inventor—the testimony must also evaluate, in detail, alternative paths that a person of ordinary skill would have chosen. An expert’s ability to quantify the number of known alternatives to achieving a certain end may be an effective tool in demonstrating a finite number of solutions—testimony that will aid in determining whether the invention was “obvious to try.”39

Similarly, in Sanofi-Synthelabo v. Apotex, Inc.,40 the Federal Circuit affirmed the validity of Sanofi’s patent covering the blockbuster drug Plavix™. The Plavix™ patent covers a dextrorotatory isomer and the invalidity question arose from the fact that the racemate of the compound was known and described in earlier Sanofi patents. Apotex argued that the separation of enantiomers is routine and that there was both motivation and means for creating the Plavix™ compound from the known racemate that Sanofi had previously admitted was an important compound. The Federal Circuit rejected this argument because “a person of ordinary skill in this field would not reasonably have predicted that the dextrorotatory enantiomer would provide all of the antiplatelet activity and none of the adverse neurotoxicity.”41

Ultimately, the expert should generally be prepared to explain the scope and content of the prior art; explain the differences between the prior art and the claimed invention; and express an opinion as to

33 Jonathon Campion & Sheila Collins, Obviousness in a Post-KSR World, in Patent Litigation 2008, at 407, 423 (PLI Patents, Copyrights, Trademarks, & Literary Property, Course Handbook Series No. 948, 2008).

34 520 F.3d 1358 (Fed. Cir. 2008).35 Id. at 1364.36 Id. (The anti-convulsive properties of the epilepsy drug were discovered by a researcher looking for an inhibitor for diabetes. The court

affirmed the district court’s denial of Mylan’s motion for summary judgment of invalidity under §103). 37 Id. 38 Id. 39 Campion & Collins, supra note 33. 40 550 F.3d 1075 (Fed. Cir. 2008).41 Id. at 1087.

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the level of ordinary skill in the art at the time of the invention and whether one of such skill would or would not have found in the invention to be obvious in light of the prior art. 42

B. Chemical vs. Mechanical Arts

The Federal Circuit affirmed the district court’s finding of non-obviousness in each of the chemical-arts cases appealed to the Federal Circuit in 2008 that addressed the obviousness issue. This is good news for owners of pharmaceutical or chemical patents. On the other hand, challenging the validity of mechanical and electrical art patents may have become somewhat easier.43

In the chemical arts, a prima facie case of obviousness for a compound normally “begins with the reasoned identification of a lead compound.”44 For those challenging the validity of a chemical arts patent, obviousness based on structural similarity can be shown by identifying some motivation that would have led one of ordinary skill in the art to select and then modify a known compound in a particular way to achieve the claimed compound.45

The mechanical and electrical arts often involve the combinations of known elements.46 Under KSR, the validity of claims to such combinations is more difficult to sustain. For example, where the claimed invention makes a routine addition of modern electronics to older devices or otherwise makes an improvement that applies known technology, the Federal Circuit has found the requisite motive to make the combination part of the knowledge and ordinary creativity of a person of ordinary skill.47

IV. Patent Prosecution Hurdles

KSR changed the landscape for both patent litigation and prosecution. Following the KSR decision, the PTO published new guidelines for patent examiners to assist them in making proper determinations regarding obviousness.48 The revised guidelines state that examiners can still use the TSM test to reject a patent, but an invention may also be found obvious without using that approach. Post-KSR, examiners can also consider the following when making an obviousness rejection: combining prior art elements according to known methods to yield predictable results, simple substitution of a known element, use of a known technique to improve similar devices in the same way, or applying a known technique to a known device ready for improvement to yield predictable results.49 In addition, the revised guidelines expand the universe of prior art to be considered by the examiners. Prior art that is in the field of endeavor other than that of the applicant, or solves a problem which is different from that which the applicant was trying to solve, may also be considered for the purposes of

42 See Frederick G. Michaud & David Schlitz, The Use of Experts to Prove Obviousness, in Patent Litigation 2008, at 429, 437 (PLI Patents, Copyrights, Trademarks, & Literary Property, Course Handbook Series No. 948, 2008).

43 See Susan A. Cahoon & Alton L. Absher III, Federal Circuit, KSR and Pharmas: The First Year and A Half, IP360 (Jan. 5, 2009). 44 Eisai Co. v. Dr. Reddy’s Labs., Inc., 533 F.3d 1353, 1359 (Fed. Cir. 2008).45 Id. at 1357 (citing Takeda Chem. Indus. v. Alphapharm Pty., Ltd., 492 F.3d 1350, 1356 (Fed. Cir. 2007).46 See Muniauction, 532 F.3d at 1326-27.47 See Cahoon & Absher, supra note 43.48 See Examination Guidelines for Determining Obviousness under 35 U.S.C. 103 in view of the Supreme Court decision in KSR Int’l Co.

v. Teleflex Inc., 72 Fed. Reg. 57526 (Oct. 10, 2007) (the “Guidelines”). 49 See U.S. Dep’t of Commerce, U.S. Patent & Trademark Office, Manual of Patent Examination Procedures (MPEP), § 2141 at 2011-119

(8th ed., rev. 6 2009). The MPEP has also been revised in light of KSR, consistent with the Guidelines.

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§ 103.50 Since examiners have more tools regarding obviousness rejections, it is likely that more § 103 rejections will issue from the PTO, thereby increasing the cost to prosecute patent applications.

In responding to post-KSR rejections, many of the arguments that were used before KSR still have application. For example, one can still argue that there is no teaching, suggestion, or motivation to combine the references, but the arguments often cannot stop there. Depending on the specific reasoning cited by the examiner, patentees should also consider addressing some of the other rationales listed in the guidelines, such as how combining the prior art elements yielded unpredictable results or the combination was done in an unknown way to yield unpredictable results.51 Patentees should also consider arguing why the combination of cited references would be impractical, expensive, or inoperative. In Andersen Corp. v. Pella Corp.,52 Andersen successfully argued that the prior art mesh would not have been considered by one of skill of the art because it was “extraordinarily expensive.”53 Andersen submitted into evidence prior art references that taught away from the cited mesh because it was unusable as an insect screen.54 In this case, by showing how the combination of the prior art references made it impractical and expensive to conceive the claimed invention, Andersen successfully overcame the obviousness challenge.

It is still too early to describe the full impact of the KSR decision on § 103 rejections by the PTO. One indicator, however, is how often the Board of Patent Appeals and Interferences (“BPAI”) upholds an examiner’s decision. The percentage of appeals affirmed or affirmed in part by the BPAI increased from 55.8 percent in 2006 to 70.0 percent in 2008.55 This suggests that the BPAI will be more supportive of examiners and more flexible in reviewing § 103 rejections.

V. Conclusion

The full impact is not yet known, but it certainly appears that examiners will make more obviousness rejections that will be upheld by the BPAI. While KSR has made it generally more difficult to refute a § 103 argument, the impact of KSR has been less dramatic in the chemical arts because of the unpredictable nature of the art. The influence which KSR is having or will have on patent litigation will take more time to fully understand.

50 Id. at 2100-117.51 Id. at 2100-129.52 Civ. No. 07-1536, 2008 U.S. App. LEXIS 24087 (Fed. Cir. Nov. 19, 2008) (Andersen sued Pella and W.L. Gore for infringement of its

window screen patent. The patented invention allows ventilation and blocks insects, but is easier to see through than traditional screens. In light of KSR, the district court granted defendants’ motion to re-open motions for summary judgment on the limited issue of obviousness).

53 Id. at *15-16 (finding that the record created a genuine issue of material fact as to “whether the durability, transparency, and pricing of the prior art mesh would have discouraged an ordinarily skilled artisan from incorporating the mesh into an insect screen.”).

54 Id. at *12-13 (finding that the prior art references taught that the cited mesh possessed many characteristics that an ordinary skilled insect screen designer would have viewed as undesirable for an insect screen).

55 See BPAI Receipts and Dispositions by Technology Centers for Ex Parte Appeals, http://www.uspto.gov/web/offices/dcom/bpai/docs/receipts/fy2008.htm (as of Sept. 30, 2008), and BPAI Receipts and Dispositions by Technology Centers for Ex Parte Appeals, http://www. uspto.gov/web/offices/dcom/bpai/docs/receipts/fy2006.htm (last visited Mar. 10, 2009).

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INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

TRADEMARK & COPYRIGHT

Protecting the Brand in China

Christopher J. Woods

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Protecting the Brand in ChinaChristopher J. Woods

I. Introduction

Although the economic express train of the past decade, China (in early 2009), may be running out of steam (in tandem with the rest of the world). That does not in any sense mean that brand owners should take their eyes off China. Although the dynamics that drove brand owners to China this century—low cost manufacturing and a rapidly developing market for high end consumer goods—are suddenly less obviously present or viable, there are plenty of reasons for the brand owner to continue to invest time, money, and resources in China. That means continuing to file trademark applications, monitoring third-party applications, taking action against infringers and counterfeiters, manufacturing goods (particularly more technically complex ones), creating demand for services locally, and establishing joint ventures and wholly-owned enterprises to market Western-branded goods to the vast population.

Economic downturns—whether local or global—can never by definition be permanent. Ultimately, recovery of some kind comes along, and it seems highly probable that, when it does, the Chinese market for goods and services will be a premier one. There are plenty of reasons for the brand owner to continue to be active in China.

The economic downturn has not affected China’s status as the preeminent nation for counterfeits. If anything, it may have enhanced it. It copies, manufacturers, and exports goods in all industry sectors, from household cleaning materials to computers, and high fashion garments to entire automobiles.

II. Counterfeits

Counterfeit goods that find their way into Western markets may have followed a circuitous route to get there. But the overwhelming likelihood is that they started their journey in the People’s Republic of China. That fact alone is enough to demand that a brand owner remain focused on China. Many factories in China no longer have full order books from foreign companies to manufacture legitimate goods. That means that they must look elsewhere for work. Making identical versions of goods that they were previously contracted to make, or making similar look-alikes, or utilizing the intellectual property or physical property (such as molds) that had previously been licensed to them provide obvious outlets for spare or under-utilized capacity.

Counterfeits can be “pure” counterfeits, where there is no legal relationship between the manufacturer and the trademark owner, or a more insidious type (in some ways) where the product is completely indistinguishable from the genuine product but is one that has not been authorized by the brand owner. The latter occurs where—usually, but not exclusively—insufficient attention has been paid by the trademark owner to the manufacturing process in China. The local factory owner produces, in addition to the documented numbers of licensed trademarked products, a large number of undocumented, and therefore unlicensed, trademarked products. Because the products are coming off the same production line, and made (usually) with exactly the same materials, they are indistinguishable from the genuine licensed product. These unlicensed products do not

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harm the market in the same way as “pure” counterfeits do—because technically and functionally the products are as good as the licensed products and therefore are unlikely to create consumer complaint—but they heavily dilute the market for the licensed product and effectively put intense pressure on premium pricing. This creates problems at the consumer level and also at the wholesale and retail level where it is apparent that consumers can purchase through various illicit outlets the exact same product for half price or less. There is, given the present situation in China, plenty of opportunity for this kind of counterfeit to proliferate.

As with manufacturing quality control generally, the key (or at least one of the keys) to the latter problem, today or at any time, is the level of supervision and control which is exercised over the manufacturing process. Oversight of the process, when it is taking place thousands of miles away is never easy, and certainly never easy on a continuous and sustained basis. Nevertheless, such control and oversight is essential, particularly in the more economically challenging times of today. The temptation to produce “over-runs,” as such excess production is often euphemistically termed, is great given the reward and relative lack of risk.

As for “pure” counterfeits, they are often regarded by foreign trademark owners and governments alike as being a problem, if not created by, then at least exacerbated by, the Chinese government. Although China has a set of modern intellectual property laws, the sense is that the Chinese government does not push hard enough for those laws to be implemented and for IP enforcement to be rigorously carried out. The counter-argument to that is that intellectual property rights are private rights and the obligation of the government is to create an infrastructure within which those rights can be enforced, but it is then a matter for the IP owner to vigorously enforce those rights.

Plainly there is some superficial attraction and rational sense to this argument. However, the extent to which a government allows rights to be openly abused in the market, and does not actively push courts and judges to impose rigorous sentences, and indeed does not create an infrastructure where sentences and penalties are amongst the highest in the world (in China they are still very low compared to the Western world) undermines the ability of a government to assert that it has done all that is necessary and that the onus is now on the rights owner.

Nevertheless, it is certainly true that the ability to reduce the problem is to a great extent in the hands of the brand owners themselves. Obviously, given the size of China and the volume of goods which are manufactured there, it is impossible for any brand owner (especially those in industries where counterfeiting is both rampant and relatively straightforward) to get its arms around the problem. The size of the problem today is such that no trademark owner can expect to eradicate the problem either in its own industry or in respect of its own trademarks. However, the extent to which a trademark owner vigorously enforces its rights in those geographical areas of China where there is a specialization in those particular goods is likely to impact on the extent to which that trade flourishes or declines.

III. Policing and Anticounterfeiting

All of the components of an effective policing and anticounterfeiting program in the U.S. are equally effective and important when taking action in China. A well thought-out plan must be in place so

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that, as in the U.S., certain steps are carried out in advance of or in parallel with specific enforcement activities. That is to say, brand owners should perform the following actions (at least) in China with as much diligence and planning as would be appropriate to the equivalent steps in the U.S.:

(1) register key marks (English and Chinese versions) and possible variants and translit-erations with the Chinese Trademark Office and record those registrations with Chi-nese customs;

(2) establish procedures for reporting problems encountered on the ground;(3) ensure that methods and systems are adopted so that genuine goods can easily and reli-

ably be identified and distinguished from fakes;(4) establish close contacts with their own factories and be willing to spend time there

with owners and managers;(5) provide training and authentication materials to customs and administrative enforce-

ment officers; and(6) identify brand owners’ groups and trade lobbying groups that are engaged in anti-

counterfeiting activities in China.

As part of a proactive approach to counterfeiting, brand owners need to consider who might be involved in the counterfeiting process, and the possible actions that can be taken. A brand owner can take action against most of the links in the counterfeit distribution chain (such as manufacturers, wholesalers, distributors, retailers, and exporters) as direct infringers.

China has a legal system that recognizes and regulates intellectual property rights. China has set up, and continues to expand, a complex network of organizations and processes to enforce its intellectual property laws. The constantly developing nature of the legal system itself, the constantly evolving means of enforcement of IP rights within that system, the changing nature of the economic scenery, and the ever changing ingenuity and resourcefulness of counterfeiters in China means that, while protection and enforcement of rights in China is both possible and necessary, a brand owner must continue to take a proactive and involved interest in China.

Broadly speaking, the causes of action that are available in China (as opposed to the means of enforcing such rights) are similar to those available in the U.S., although there is much less protection for unregistered marks in China than in the U.S.

IV. Infringement of a Registered Trademark

The following acts constitute infringement of a trademark (either a national registration or an international registration designating China):

(1) to use a trademark that is identical to, or similar to, a registered trademark in respect of the identical or similar goods without authorization;

(2) to sell goods that the seller knows bear a counterfeited registered trademark;(3) to counterfeit, or to make without authorization, representations of a registered trade-

mark of another person, or to sell such counterfeit representations of a registered trade-mark without authorization;

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(4) to replace, without consent, a registered trademark and to put such goods bearing the replaced trademark on the market again;

(5) to provide transportation, storage, mailing, concealment, or other assistance in order to facilitate others in the infringement of a registered trademark; or

(6) to cause, in any other way, prejudice to the exclusive right of another person to use a registered trademark.

V. Unfair Competition

China’s Anti-Unfair Competition Law provides some protection for unregistered trademarks and their labeling and packaging, but it is a far from satisfactory law. In short, though, a business may not, under the provision of the Anti-Unfair Competition Law, use the identical name, packaging, or trade dress of famous or well-known products, and may not use a confusingly similar name, style of packaging, or trade dress of a famous product. There are draft revisions to the Anti-Unfair Competition Law that are meant to strengthen protection in unregistered marks, but such revisions have been pending for years.

The Trademark Law also extends protection to a “well-known” trademark. Such a mark can be registered or unregistered. The protection enables a trademark owner to take action against a mark that is similar to:

(1) a mark that is not registered in China but which is being used in China on identical or similar goods and such mark is capable of causing confusion; or

(2) a mark that is registered in China and that is being used on non-identical or dissimilar goods and such mark may mislead the public and be likely to prejudice the well-known trademark.

The Trademark Office grants well-known status upon review of a specific application by the trademark owner that sets out:

(1) the reputation of the mark in China;(2) the length of use of the mark;(3) the duration, scale, and geographical scope of any publicity for the mark;(4) the owner’s history of enforcement actions taken to protect the mark in China; and(5) other factors contributing to the reputation of the trademark.

VI. Cease and Desist Letter

Although not always the most obvious step to a foreign trademark owner in China, the first step in an infringement case is often to consider whether the matter can be resolved through direct contact with the person or entity making or selling the counterfeit goods.

It is not out of the question, even today, that an infringer may be a small-time operator (albeit responsible for the production of large numbers of goods) who is essentially ignorant of the law and its requirements. Copying goods in China has been illegal for nearly three decades and although

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previously there was a cultural acceptance and encouragement of copying, that is now moving into the distant past. Most factory owners today, especially of large enterprises, are well aware of the legal implications of copying western branded goods. Nevertheless, there are still many smaller operations where the owner is unaware of the illegality of the activity, or is operating under various misapprehensions as to why its particular activities are not against the law. These misapprehensions include beliefs that changing a single letter in a registered trademark renders it no longer an infringement, and that making a specific number of visual changes to the design of a product (the number is often believed to be five) renders it no longer a copy.

Direct contact with infringing manufacturers, usually via local counsel and in writing (in Chinese), can sometimes assist in dispelling myths and misunderstandings, and can sometimes achieve more than might be anticipated. The aim of such contact is often educational and instructive, and the letter will not use the typical language of an aggressive cease and desist letter. The language, although firm, will not be inflammatory, and will seek to explain the law to the manufacturer, and how the law applies to the specific facts. A small-time manufacturer may be ignorant of the law, or may be ignorant of the fact that his goods are the subject of third-party registered rights. The manufacturer may know of all the relevant facts, however, but will instinctively view interference by a foreign corporation as a heavy-handed attempt to exercise unfair and unreasonable restraint on competition. A well-worded letter (often followed by a telephone conversation with local counsel) can go a long way towards dispelling this perception.

A follow-up face-to-face meeting can sometimes also be productive. If the process does ultimately elicit a positive response, a written undertaking to cease manufacturing the counterfeit goods should be signed in English and Chinese by the counterfeiter. Written details should also be obtained of customers (either end-user customers or the supplier of the instructions to manufacture), together with delivery up or supervised destruction of any stock. Those should be the primary elements the brand owner seeks and expects from settlement. It is very unlikely, however, for the brand owner to obtain compensation from small scale manufacturers.

In some settlements the trademark owner will itself offer some incentive to stop the infringing activity. This might include working with the factory to become a legitimate supplier or it might involve a broader range of philanthropic steps (such as a school endowment) intended to help the town or village as a whole. Forcing a factory to cease producing lucrative (but infringing) goods often results in unemployment and financial hardship for a broad swathe of people. Achieving cessation of infringing activities without causing hardship and resentment is a difficult act but one that can be achieved if a company is prepared to put the time and effort into the program. The key to achieving a lasting settlement is not only to be as reasonable as is feasible, but also to remain engaged subsequently. Even if this does not involve any philanthropic engagement with the local community, it should involve follow-up activity to ensure that the previously infringing manufacturer is adhering to the terms of the settlement.

For every case that is capable of being settled, however, there are many more (most, in fact) that are not. Many manufacturers today are engaged in blatant and knowing counterfeiting of trademarks, or deliberate infringement of marks, and are not intimidated by threats. Warning letters and negotiations

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will not succeed with institutional or repeat infringers and indeed communication with such entities can compromise the possibility of successful raid actions by the authorities.

VII. Administrative Action

Where settlement is impossible, the Chinese government has set up various administrative enforcement bodies to deal with infringement matters. Today, there are well over 7,000 full-time trademark administration personnel throughout China.

The Administration for Industry and Commerce (“AIC”) regulates trademark infringement and unfair competition. Local offices of the AIC carry out the administrative enforcement of trademark disputes. Brand owners generally file complaints with the AIC in the location where the infringement occurred, and the AIC does not charge for its work. This apparent cost benefit is quickly undermined, however, by the consequences of not charging fees. The absence of revenue means that AIC officers lack (often significantly) the resources—financial as well as headcount—necessary for competent enforcement action. Trademark owners are often required, out of necessity, to provide missing resources such as finance, manpower, and transportation.

The procedures vary from region to region. However, an AIC office is bound to take action on the submission of a proper complaint supported by adequate evidence of infringement, and will often take action very quickly—usually within a few days, and in some cases within hours. Adequate evidence usually requires that the brand owner has conducted an investigation into the activities complained of and submitted a written report to the AIC. If, after consideration of the complaint and the supporting evidence, the AIC considers there are grounds to conclude that infringements have occurred, it can take a number of steps.

Trademark owners usually request the AIC to conduct a raid at the premises of the infringer and to seize or destroy infringing goods. The AIC has a wide range of powers which it can employ to this end. In particular, it can:

(1) question the infringer;(2) order the infringer to immediately cease the infringing act;(3) examine, seal up, seize, and destroy the counterfeit goods;(4) seize dies, moulds, printing plates, and other tools used in the infringement;(5) examine and take copies of contracts, books of record, and other business materials

relating to the infringing acts; and(6) in a non-criminal case of infringement, impose a fine of up to three times the illegal

revenue.

When it is impossible to assess the amount of revenue, the ALC can impose a discretionary fine of up to 100,000 RMB. The ALC has no power to order compensation to the brand owner. This power is reserved to the courts. Although there are advantages to AIC actions, particularly their speed and general cost effectiveness, there are practical drawbacks, especially in all but the most factually straightforward of cases.

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AIC officers have now become much less willing to act on a complaint signed by an agent on behalf of a foreign brand owner, and require a notarized and legalized Power of Attorney from the owner to the agent before taking action. This can be a long drawn-out process, and often delay is fatal to a raid action where stock and evidence can disappear very quickly. It makes good sense to anticipate this issue and to have the paperwork prepared and executed in advance of any possible enforcement activity.

Although the AIC can impose a fine of up to three times the illegal revenue, the fines levied in practice are often so low that infringers regard administrative fines as a cost of doing business. Repeat infringements or infringement in violation of an administrative order to cease infringing actions rarely carry increased levels of fines.

There is also the issue of local protectionism and corruption. A local AIC office may be very unwilling (overtly or otherwise) to act where local businesses employ many people in the production of counterfeit goods.

Even in the absence of corruption, local AIC’s are often only willing to accept infringement cases which are straightforward. That is, where the goods and mark are identical to the original product and mark. Where even slight changes to the goods have been made, or the infringer makes goods bearing an identical mark but on goods which are not identical to goods covered by the trademark registration, the AIC can be reluctant to act. In addition to the AIC, another administrative body—the Technical Supervision Bureau (“TSB”)—also has power to act against counterfeit products. The TSB is, like the AIC, locally appointed. The TSB is a division of the local government, and is the agency primarily responsible for ensuring that locally made products comply with technical standards under the Product Quality Law. Counterfeit products are generally taken to be a violation of the Product Quality Law (no matter how “good” a copy they may be) and accordingly come within the jurisdiction of the TSB. TSB officers have powers of search and seizure that are similar to those of AIC officers, and they also have the ability to impose fines and to destroy products and the means for making them. Administrative agencies also exist in respect of copyright infringement (the National Copyright Administration) and patent infringement (which is covered by the State Intellectual Property Office).

VIII. Court Action

The Court System is much improved in recent years, and foreign brand owners have begun to file lawsuits in ever-increasing numbers. The majority have been in the major cities, but many lesser venues are also seeing greater activity on the IP front. The courts are divided into four primary levels:

(1) the Basic People’s Court (cases of first instance);(2) the Intermediate People’s Court (important cases involving foreign parties, and ap-

peals from the Basic People’s court);(3) the Higher People’s Court (important cases of first instance, and appeals from the In-

termediate People’s Courts; and

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(4) the Supreme People’s Court (cases with important issues of law or jurisdiction, and other significant cases which it wishes to accept).

Each People’s Court is divided up into civil, economic, administrative and criminal chambers. From an IP enforcement perspective, the most important are the IP Chambers within the civil and economic chambers. IP Chambers were first established in the Beijing Intermediate People’s Court nearly two decades ago, and Intermediate People’s Courts in many major cities have subsequently set up the same type of chambers to handle intellectual property-related cases. The primary benefit of these chambers within the court system is that they are specially focused on IP disputes. Accordingly, the judges have specialized backgrounds and training in order to enable them to deal with IP cases competently and efficiently.

Brand owners can bring action where the defendant lives and does business, or where the infringement occurred. In order to file suit:

(1) the plaintiff must have a direct and substantial interest in the matter;(2) there must be an identifiable defendant or defendants;(3) there must be a recognizable claim; and(4) the court must have jurisdiction.

The key requirements for a preliminary injunction in China are relatively straightforward:

(1) the applicant must be the rights holder or an interested party; (2) the person against whom the injunction is sought is, or will be, committing an infringe-

ment of the registered right; and (3) the infringement will result in irreparable harm (i.e., not readily compensated in dam-

ages) to the lawful rights and interests of the rights holder, if not immediately stopped.

The ability to apply for a preliminary injunction exists only in respect of registered marks. There is no such ability in respect of an action under the unfair competition or well-known trademark laws.

Following an application, the court will make a written ruling within forty-eight hours. If the application is successful, the applicant is required to provide security in an amount determined according to the value of the goods in question. A court officer, which can mean the judge to whom the case was assigned, will immediately serve the injunction. The defendant is entitled to a review of the injunction, and the plaintiff is required to file civil proceedings within a specified timeframe following the grant of the injunction.

Civil litigation in China, on behalf of a foreign plaintiff, is relatively fast; most straightforward cases are resolved in the first instance within six months to a year. After all preliminary steps including investigation have been completed (which can be costly depending on the facts), a straightforward trademark infringement case (where there are no complicating factors, and the mark is identical and

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is used on goods for which the mark is registered) can be carried out for a fraction of the cost of a similar action in the U.S.

The brand owner must serve the complaint on the court. The court then serves a copy of the complaint on the defendant within five days. The defendant has fifteen days to serve a defense.

In cases where evidence or property is at risk, the brand owner may seek pre-action orders from the court immediately upon service of the complaint at the court. The judge assigned the case will often serve the order personally. If the defendant is some distance from the court (and it is possible to effectively forum shop in China), the cost can be increased significantly by having to pay to transport the judge (or sometimes two judges) to and from the defendant’s location. However, there are physiological advantages in having the judge confront the defendant in the process, and practical ones, too, as the judge can get a real sense of what is going on and how dishonest (or otherwise) the business and its personnel seem to be.

While many aspects of litigation in China are, in theory, not dissimilar to the processes elsewhere in the world, the process of evidence gathering is very different.

Discovery is still, by U.S. standards, non-existent. It is, in common with other civil code jurisdictions, essentially voluntary. The rules do not permit parties to seek (or demand) discovery from each other. Accordingly, the evidence generally before the court is evidence that the parties have accumulated themselves. Where a party cannot obtain evidence that it needs, it can seek the assistance of the court. This can be by way of an order of the court preserving particular evidence so that it cannot be removed or destroyed—again, the judge will often travel to the defendant’s premises to execute such an order and to take the evidence away if it is capable of being moved. Or, the court can order that the plaintiff be permitted to collect evidence from the defendant through an investigation. The court can also order an AIC office to turn over evidence obtained by it in a raid action against the defendant.

Chinese courts follow the “best evidence rule,” which means that original documents must be submitted in order to be admissible. This is often a very difficult standard to meet for foreign brand owners.

In order for evidence created in jurisdictions outside of China to be admitted into evidence, it has to be notarized, legalized, and translated. This process is not only cumbersome and time consuming, but can be very costly.

Just as there are no rules as to the collection of evidence, there are no rules as to admissibility of evidence (which is determined by the court), nor are there specific rules on the probative value of evidence, the presumptions that can be drawn, or even the requisite burden of proof the parties must satisfy.

The trial, which is generally in open court, follows a fairly straightforward path:

(1) opening statements by the parties;(2) live witness evidence, written statements of witnesses and documentary evidence;

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(3) expert witnesses;(4) statements of independent specialists on the evidence;(5) oral argument by the parties; and(6) final statement of the parties.

However, the reality is often somewhat less ordered than this would suggest, and where the defendant is represented by an unskilled or inexperienced lawyer, or is appearing pro se, the process does not closely resemble a trial but more an argument over a series of often unrelated or irrelevant issues. It is important for plaintiff’s counsel to try to keep the process focused on the issues set out in the complaint.

The court renders a written decision subsequently. The written decision sets out the facts and law the court relied on and will set out the reasoning for the decision. It may make an award of court costs and will, if the plaintiff was successful, set out the remedies. In most courts, the judgment becomes a public document. Remedies can include some or all of the following:

(1) an injunction;(2) delivery up and disclosure of information;(3) a public apology;(4) damages; and/or(5) expenses incurred in stopping the infringement, including but not limited to legal and

investigation fees.

The plaintiff elects the basis upon which the court calculates damages and can include:

(1) the actual loss suffered by the plaintiff (plus appropriate expenses incurred in order to stop the infringements);

(2) the illegal income of the defendant (plus appropriate expenses incurred in order to stop the infringements); or

(3) an amount not exceeding 500,000 RMB (approximately $60,000 USD) if the plaintiff cannot establish (a) or (b) above (i.e., statutory damages).

If the defendant does not comply with the terms of the order, the bailiff of the court commences enforcement of a judgment within fifteen days of a petition to do so. The court is permitted, if it can locate it, to seize all of the defendant’s property, including personal and real property, save only for tools of the trade needed by the defendant and his family for their livelihood.

Some courts, as in the U.S., are better than others. Forum shopping does occur, more frequently today than in the past. Some courts are more pro-plaintiff (or at least are not rampantly pro-defendant). Some courts, as did the Intermediate People’s Court in Shenyang last year, hold particular sessions every so often which focus especially on IP cases. During the “IP Week” in Shenyang in Spring 2008, a number of important IP cases were heard, and the written judgments (available through the court itself) show an awareness of the issues at stake and the need for effective and decisive judgments.

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When a court such as this is identified, it makes good sense for a plaintiff with a defendant in a poor jurisdiction for court enforcement to look for examples of sales of those goods in the jurisdiction of a more sympathetic court.

The problem with suing a defendant outside its home jurisdiction does mean that, as indicated above, the judges may have far to travel in order to execute specific orders. Alternatively, if the judge asks the local court to execute the order on its behalf, the risk of corruption and favoritism comes back to the forefront.

Corruption and favoritism does exist at all levels in China, where it is rarely seen as such, although in the more Westernized regions and in the higher courts with educated judges, its prevalence is much reduced. The lower courts are more infected than the higher courts, so another form of forum shopping (where the defendant is located in the jurisdiction of a court predisposed to local favoritism) is to avoid the local intermediate court altogether and bring suit in the Higher People’s Court.

Damage awards are generally limited to the maximum available by statute: 500,000 RMB. Damages in excess of statutory damages can be awarded, and in some notable cases significantly so,1 but this is rare. To obtain more than the statutory tariff, it is necessary to show and prove actual damages. Given the highly restricted approach to discovery, such proof is often extremely difficult to come by. Most, but not all, cases where significant damages have been awarded have been where the plaintiff was Chinese.

For most foreign plaintiffs, the purpose of suing is not to collect a substantial damages award (although where the defendant is itself a large Chinese corporation, this may not be so) but to force the infringing activity to stop, and to attract significant publicity pursuant to that. Successful foreign plaintiffs gain a great deal of positive press, in China and worldwide, and this (plus the often enforced requirement upon the defendant to publish an apology in the process) does create a dynamic which, to a degree, may discourage copying of that plaintiff’s products. An alternative approach is to settle the matter just before trial. Enforcement of the terms may still be problematic, but sometimes a voluntary set of requirements may be more readily complied with than the mandatory requirements of the court.

Another problem in enforcing a judgment, or even bringing an action in the first place, is the corporate web in which many Chinese companies exist. Many companies are formed with similar names so that it is hard to know which is the correct party, and there are often, within the web, a number of Hong Kong companies. The difference in the financial and legal systems between China and Hong Kong means that defendants can transfer funds easily and can keep money and assets in Hong Kong to complicate the enforcement process.

It is very difficult to pierce the corporate veil in China and get to the individuals responsible for the corporation. Individuals can blatantly be carrying out the infringements, and harvesting the rewards,

1 See Christopher J. Woods & Linda Du, A Victory for Yamaha and China, Trademark World, Apr. 2008, at 33 (discussing the damages award by China’s highest court to Yamaha—8.3 million RMB (approximately $1.1 million USD), the largest award of damages made in China where a foreign company was involved—due to the unauthorized use of Yamaha’s trademarks by four Chinese companies).

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yet are doing so behind the shield of a corporation with few assets and, as it later turns out, may be wholly-owned by a Hong Kong company against which action is difficult or impossible.

As with discovery, Chinese courts lack strong investigative powers. In an asset preservation action, the court may go to a bank and freeze a certain account number belonging to the defendant. However, it is not uncommon for the bank to refuse to disclose to the court all account numbers belonging to the infringer. The success of an asset preservation order will generally depend on timing and luck, but certainly if luck is on the plaintiff’s side, such an order can be useful.

IX. Criminal Prosecution

Infringement of trademarks is a criminal offense in China. Different penalties are applicable depending on the circumstances of the infringement including whether the infringements were “serious” or “exceptionally serious,” and whether the sale of goods bearing the counterfeit trademarks were “relatively large” or “very large.” That vagueness hampered criminal prosecutions until the law was changed to allow prosecutors to pursue criminal charges where a specified threshold amount is involved. Thus, where the value of infringing products seized and/or sold exceeds the threshold (the amount depends upon whether the infringer is an individual or a corporation), the brand owner should seek prosecution. If a repeat offender is caught at least three times, he will be subject to criminal prosecution if just eighty percent of the threshold figure is reached. In addition to fines, a convicted infringers can be imprisoned for a period ranging from three to seven years. Where the AIC or TSB carries out administrative action and discovers that the amounts involved meet the threshold for a criminal prosecution, the case must be transferred to the Public Security Bureau for criminal prosecution.

X. Customs

For the past decade, trademark owners have been able to record and enforce their trademarks through Chinese customs. Although it is no longer a prerequisite (for seizure of goods) to have the trademark recorded with customs, it is advantageous to do so since customs can act on its own initiative to make seizures if the mark is recorded with it.

Customs operates a centralized recordal system at the General Administration of Customs in Beijing. To record a mark, copies of the trademark certificates and certificate of incorporation need to be lodged. The General Administration of Customs then decides whether to grant a recordal within thirty working days, which is effective for ten years or the balance of the term of the registration. Recordal with customs, although it can take several months to achieve, is inexpensive and straightforward. Additionally, it is useful for brand owners to offer training courses for Customs officers, as it enables them to have specific brands in mind and to be able to spot fakes easily.

If the trademark owner becomes aware of possible violations of its rights, in particular the export of goods bearing counterfeit marks, the owner should make a written application with customs, requesting it to take specific protective measures. A brand owner can apply for goods to be detained if it has knowledge of the import or export of infringing goods, or if it has been notified of a seizure of a shipment by customs acting on its own initiative (where the relevant mark has been recorded). If

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the trademark owner requests that the goods be detained, the trademark owner is required to provide a surety or place a bond with customs, not exceeding the value of the goods. If the value of seized goods is under 20,000 RMB, the amount of the bond is the same as the value of the seized goods, but if the value of the seized goods is above 20,000 RMB, the bond is equal to 50% of the value up to 100,000 RMB. A brand owner can post a general bond of 200,000 RMB for multiple seizures. To qualify for the right to post a general bond, the brand owner must have recorded its marks with Customs and also have applied for detention of goods several times in the past. The trademark owner must also reimburse customs for all storage costs incurred in the detention of the goods. Customs will deduct these costs from the bond if the owner fails to make payment.

Once customs detains the goods, it will conduct an investigation into whether the goods are infringing. Goods that are non-infringing are returned, unless the trademark owner has made an application to the People’s Court for a property preservation order and the court has issued notice to customs to retain the goods. If infringing goods are found, customs will hold them and notify the trademark owner, who has three days to decide whether to detain the goods. If the owner confirms the goods are infringing and requests detention, the bond is then payable. If the goods are non-infringing, they will be released with no liability to Customs or the trademark owner.

A seizure by customs is highly effective because it removes the products from commerce, and those seized products are available to be used in subsequent actions. A seizure is also likely to reveal information about the intended destination of the goods and the identity of overseas infringers. Customs seizures are a very important tool for the brand owner, but there are several issues involved, and it is worth spending time fully understanding the system.

XI. Conclusion

“Protecting the brand in China” may appear to be something of an oxymoron. The concept of a brand being afforded any protection in China seems, given the dismal reputation that China has for the protection of IP rights generally, rather unlikely. Historically, the process of copying in China has been lauded, representing a cultural norm for an apprentice to learn his or her trade by copying the skills of an acknowledged master. That approach to copying has had a lingering effect in China, and one that is visible in the approach taken by local manufacturers to foreign-branded goods. Nevertheless, during the nearly 30 years in which the trademark law has been in effect in China, there have been significant changes in attitudes of consumers to brands generally (a desire for, and an ability to pay for, genuine foreign-branded goods) and a steadily increasing recognition by the government and judiciary of the need to enforce IP rights to protect those brands. Plainly, there is still a long way to go and it may well be that there is sufficient demand for counterfeit or look-alike products globally so that China will never lose its status as the primary producer of such goods. However, there is an infrastructure and a desire in China to assist the brand owner in protecting the brand in China. With sufficient resolve and financial resources, together with a pragmatic approach, a brand owner is capable of protecting the brand in China much more ably than would have been possible ten years ago. Although the system is far from perfect, there are procedures and remedies that are familiar to trademark owners the world over. A trademark owner has a considerable ability

KILPATRICK STOCKTON

to protect the brand in China if it has the willpower to do so, and a willingness to accept that the system, and the local approach to it, is still evolving.

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

TRADEMARK & COPYRIGHT

Protection of Product Designs

John S. Pratt, R. Charles Henn, Jr., Alicia Grahn Jones, Lauren T. Estrin, and Michael A. Bertelson

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Protection of Product DesignsJohn S. Pratt, R. Charles Henn, Jr., Alicia Grahn Jones, Lauren T. Estrin, and Michael A. Bertelson

The United States was founded in part on the notion that people should generally be free to do as they please, and that concept is central to this country’s approach to design copying. Among the fundamental assumptions of American jurisprudence is the belief that the public is best served if there is free competition, the widespread dissemination of ideas, and a legal environment that encourages product copying, so that innovations will be widely available and the public will be benefited as the most economical producers are rewarded.1

As a result, legal prohibitions on copying of products, whether the function, appearance, or some other aspect of the product is copied, are relatively narrow exceptions to the general policy of United States law that product copying is a benefit to the public and is to be encouraged.2 Apart from restrictions on the manufacture, sale, or use of the products that originate in safety-related concerns (such as those applicable to drugs), attorneys generally think in terms of only four categories of exceptions, which are often referred to as “intellectual property:” patents, trademarks and trade dresses, copyrights, and trade secrets. Generally, it is necessary to identify rights that have been infringed in one or more of these types of intellectual property to obtain assistance from the U.S. legal system in stopping, or securing compensation for, unauthorized copying of a product design.3

Patent, copyright, and trade secret rights will typically be fully available when copying occurs only if appropriate steps have been taken in advance to establish or protect these rights. Almost paradoxically, the trade dress rights that are the most important aspect of trademark and unfair competition protections against certain types of design copying cannot be fully created in advance, but are acquired only with the passage of time and development of public recognition. Nevertheless, other aspects of trademark and trade dress rights can be established from the beginning, and planning can make a critical difference in the development of valuable rights.

As a result of the need to act in advance, many designers and manufacturers are unable to do anything about the first instance where their designs or products are copied. Planning, often motivated by that first experience, can, however, dramatically enhance the designer’s or manufacturer’s ability to respond when later products are copied.

I. Patents

Patents are frequently the strongest protection against product or design copying. In the United States, patent protection comes in two forms: “utility” patents and “design” patents.

1 See, e.g., Bonito Boats, Inc. v. Thunder Craft Boats, Inc., 489 U.S. 141, 151 (1989) (“The attractiveness of [the patent system’s grant of monopoly in return for disclosure], and its effectiveness in inducing creative effort and disclosure of the results of that effort, depend almost entirely on a backdrop of free competition in the exploitation of unpatented designs and innovations.”).

2 Id. (“[F]ree exploitation of ideas will be the rule, to which the protection of a federal patent is the exception.”) 3 There are modest exceptions such as the protection of boat hull designs under Vessel Hull Design Protection Act and aspects of electronic

chip design under the Semiconductor Chip Protection Act.

KILPATRICK STOCKTON

A. What Patents Protect

Utility patents are available for virtually anything made by the hand of a human.4 They can protect how a thing is made, what it is (in the case, for instance, of a chemical composition of a drug), how a thing is done, or how it works.5 As a general proposition, utility patents do not protect the appearance of products except to the extent that appearance is a consequence of a protected process of manufacture or a protected function. The drawings in utility patents serve to assist in describing the invention, but the scope of utility patent protection is established by written descriptions of the invention, called “claims.”

By contrast, design patents protect solely the appearance of products, specifically the ornamental aspects of the appearance of articles of manufacture.6 Design patents consist principally of drawings, and those drawings determine the protection that a design patent establishes. Accordingly, a utility patent would be sought on a new manufacturing process for producing a chair, a carpet tile, a new backing structure for carpet, or a new tilting mechanism for a swivel chair, for example. A design patent would be sought to protect the appearance of a new design for a Windsor chair, a chest of drawers, or a new multi-height yarn pile carpet pattern. Portions of examples of both design and utility patents are reproduced at the end of this article. Under current U.S. law, and subject to certain limited exceptions, utility patents issuing from applications filed on or after June 8, 1995, generally remain in force for twenty years from the application filing date,7 while design patents have a term of fourteen years from the date the United States Patent and Trademark Office (“PTO”) issued the design patent.8

B. What Patents Are

Patents are often described as a grant by the government of the exclusive right to make the product or practice the invention covered by the patent.9 This description is not entirely accurate, however, because the fundamental assumption in the United States is that no one needs permission to make a product—apart from exceptional situations. Consistent with that assumption, a U.S. patent is instead a grant by the U.S. government to the patent owner of the right to exclude others from making, using, importing, or selling that which is covered by the patent.10 Thus, patents are neither self-enforcing nor enforced by the government. A patent owner can choose to seek enforcement of his right to stop others from practicing his invention, but need not do so. Another consequence of the fact that a patent is merely a right to exclude others is that possession of a patent does not insure that its owner can manufacture or sell the product covered by it without objection by others. For

4 Diamond v. Chakrabarty, 447 U.S. 303, 309 (1980).5 35 U.S.C. § 101 (2000) (including a “process, machine, manufacture, or composition of matter, or . . . improvement thereof”).6 Id. § 171 (“Whoever invents any new, original and ornamental design for an article of manufacture may obtain a patent therefor, . . . .”).7 See id. § 154(a)(2). Under certain circumstances, the term of drug patents can be extended to compensate for regulatory delays associated

with approval of new drugs for marketing. Id. § 156 (2000 & Supp. V 2005). Moreover, the term of any utility patent issuing from an application filed on or after June 8, 1995, that refers to an earlier filed application under 35 U.S.C. §§ 120, 121, or 365, will be twenty years from the date of the earliest application filed.

8 35 U.S.C. § 173 (2000).9 See, e.g., Jerry Lazar, What Means What, Metropolis, Oct. 1990, at 65.10 35 U.S.C. §§ 154, 271 (2000 & Supp. V 2005).

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instance, the product may also be covered by a patent owned by another or it may be the subject of safety-related regulations such as those applicable to drugs.

C. Inventions that are Patentable

Both design and utility patents are available only with respect to inventions that are new, which means that exactly the same thing has not been done before, and non-obvious, which means that, taking into consideration what was known and done before the invention, it would not have been obvious at the time of the invention to one of ordinary skill in the relevant art to make the invention. Determination of whether an invention is non-obvious is frequently complex. It is safe to assume, however, that any design or invention that one believes to be new, in the sense that one is not aware of anything exactly the same having been done before, is potentially patentable. Whether a new invention is “sufficiently innovative” to be patentable is typically not something someone unfamiliar with patenting can determine.

D. When a Patent Must be Sought

It is of critical importance that a U.S. patent be applied for (if at all) within one year after the first sale, offer for sale, or public use of the invention in the U.S., or publication of a description of the invention anywhere in the world. Under the laws of most commercially important countries other than the U.S., this one year “grace period” is unavailable, and a patent must be applied for (in at least one country) before any such commercial activities or public disclosure occurs. As a result, if a patent is not sought early, it cannot be obtained at all. Moreover, if a new invention is sold or otherwise publicly disclosed without filing a timely patent application, as a general proposition, that invention is “dedicated to the public” and may freely be copied by anyone. There are, however, circumstances in which trade dress rights or copyrights are infringed by copying, and those types of intellectual property can be asserted despite the absence of a patent.

E. The Value of Patents Today

While both design and utility patents went through a long mid-twentieth century period during which they were held in relatively low esteem by the business and legal communities, that situation has changed decidedly in recent years. There is today a substantial amount of litigation involving patents, which have become powerful competitive tools. Although some litigation results in determinations that the patents are invalid, the validity of patents is more frequently upheld, and multi-million dollar verdicts in favor of patentees have become relatively common. Far more patents prevent or stop copying, or earn license royalties, because their validity and applicability are never challenged.11

F. Design Patents

Most patents obtained and asserted in litigation continue to be utility patents; however, design patents are the subject of substantial recent activity and have been found in certain fields, such as athletic shoes, flashlights, lighting fixtures, and furniture, to be very attractive mechanisms for

11 The fate of patents in litigation is not a direct indicator of their validity or value generally, because strong, clearly infringed patents rarely go to trial. Those patents are either respected without litigation or in pretrial settlements.

KILPATRICK STOCKTON

thwarting copying.12 Reasons for such recent interest in design patents include the facts that they are relatively easier and less expensive to obtain than utility patents and, because they consist largely of drawings, they can be easier to litigate. The court and jury can simply compare the drawings to the accused product and typically need not be educated in the arcane details of a manufacturing technology, as is often the case in utility patent infringement cases.

The test for infringement of a design patent was stated by the U.S. Supreme Court in Gorham Manufacturing Co. v. White:13

[I]f, in the eye of an ordinary observer, giving such attention as a purchaser usually gives, two designs are substantially the same, if the resemblance is such as to deceive such an observer, inducing him to purchase one supposing it to be the other, the first one patented is infringed by the other.14

When comparing the resemblance between two products, the trier of fact must view the patented design in its entirety as it is claimed: “[T]he ultimate question requires determining whether ‘the effect of the whole design [is] substantially the same.’”15

The U.S. Court of Appeals for the Federal Circuit has recently clarified that the Gorham test for substantial similarity is not always limited to just a comparison between the patented and accused designs, but can also take into account any prior art designs that are close to the patented design. In Egyptian Goddess v. Swisa, the Federal Circuit stated that “[w]here there are many examples of similar prior art designs . . . differences between the claimed and accused designs that might not be noticeable in the abstract can become significant to the hypothetical ordinary observer who is conversant with the prior art.”16

Although applications for design patents submitted to the PTO often remain pending for periods on the order of one to two years, they are frequently granted without any initial rejection by the patent examiner, which is rare in the case of utility patents. This may be the case in part because the test applied by the examiner to determine whether a design sought to be patented is obvious (and therefore not patentable) is not very rigorous:

In considering patentability of a proposed design the appearance of the design must be viewed as a whole, as shown by the drawing, or drawings, and compared with something in existence—not with something that might be brought into existence by selecting individual features from prior art and combining them, particularly where combining them would require modification of every individual feature, . . . .17

12 See, e.g., Avia Group Int’l, Inc. v. L.A. Gear Cal., Inc. 853 F.2d 1557 (Fed. Cir. 1988), abrogated by Egyptian Goddess, Inc. v. Swisa, Inc., 543 F.3d 665, 88 U.S.P.Q.2d 1658 (Fed. Cir. 2008); see also Perry J. Saidman & Mark B. Mondry, Sneakers, Design Patents and Summary Judgment: Opening a New Era in the Protection of Consumer Product Designs., 71 J. pat. & tradeMark off. soc’y 524 (1989); 35 U.S.C. § 171 (2000).

13 81 U.S. 511 (1871).14 Id. at 528.15 L.A. Gear, Inc. v. Thom McAn Shoe Co., 988 F.2d 1117, 1125 (Fed. Cir. 1993) (second alteration in original) (citations omitted).16 Egyptian Goddess, Inc. v Swisa, Inc., 543 F.3d 665, 678, 88 U.S.P.Q.2d 1658, 1668 (Fed. Cir. 2008) (Fed. Cir. 2008) (en banc).17 In re Rosen, 673 F.2d 388, 391 (C.C.P.A. 1982) (quoting In re Jennings, 182 F.2d 207, 208 (C.C.P.A. 1950), overruled by, 590 F.2d 911

(1979)).

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The In re Rosen case, quoted above, involved an application for a design patent and illustrates the type of analysis conducted in determining whether such patents should be granted. Mr. Rosen sought a design patent for his design for this coffee table:

The patent examiner rejected the application, arguing that the design was an obvious modification of the following desk:

The patent examiner also called attention to two circular tables, including the following:

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and to a display stand having thin V-shaped legs having slots to receive the top, arguing that these taught the features of the Rosen coffee table design not included in the desk:

The court of appeals reversed the examiner, ruling that the Rosen design for a coffee table was patentable. Among other things, the court rejected the examiner’s argument that the new design was a mere “regrouping” of known furniture elements because there was not a previous design that this purported “regrouping” might modify.18

The Federal Circuit has also stressed the importance of comparing an accused design to the claimed patent design, and not to a commercial embodiment of the claimed design.19 In Payless Shoesource Inc. v. Reebok International Ltd., the lower court was held to have improperly considered “commercial embodiment” features not included in the patentee’s claimed shoe design in finding that the counterclaim defendant’s design was non-infringing.20 In another case, the Federal Circuit reversed a finding of infringement where the lower court relied upon similarities between the

18 Id. at 389, 391.19 998 F.2d 985, 990 (Fed. Cir. 1993).20 Id. at 990–91.

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defendant’s design and unclaimed design elements in the commercial embodiment of the patentee’s jack-o-lantern lawn bags.21

Patentees often exclude design elements from the drawings submitted to the PTO in order to broaden the scope of the resulting patent. For instance, in accordance with the court’s holding in In re Zahn,22 portions of the design can be shown in broken lines to indicate that those portions of the design are excluded from the scope of the patent. Thus, U.S. Design Patent No. 257,511, for a “Drill Tool or the Like,” covers any drill tool that has a shank substantially similar to the shank shown in the figures of that patent, regardless of whether the accused device has a substantially similar cutting portion:

Other techniques for broadening the scope of design patent drawings include showing less detail in the drawings or showing fewer views of the product design. For instance, if the underside of a chair or the back of a dresser is not a significant component of the product’s ornamental design, those drawing views can be omitted from the drawing sets submitted to the PTO.23

Although the damages available to a patent owner for infringement of a utility patent under 35 U.S.C. § 284 can be substantial,24 damages may be awarded for infringement of a design patent under both the general damages provision of § 28425 as well a special damages provision (§ 289) applicable only to design patents.26 This further enhances the potential attractiveness of design patents in preventing product copying.

II. Trade Dress and Unfair Competition

A. Causes of Action Under the Federal Lanham Act

After utility and design patents, the most significant avenue of protection available to owners of distinctive product designs lies in the portion of trademark law relating to “trade dress” infringement. As one court has defined this term, “‘[t]rade dress’ involves the total image of a product and may

21 Sun Hill Indus. v. Easter Unlimited, 48 F.3d 1193, 1196 (Fed. Cir. 1995).22 617 F.2d 261 (CCPA 1980).23 See, e.g., Contessa Food Prods., Inc. v. Conagra, Inc., 282 F.3d 1370 (Fed. Cir. 2002).24 See 35 U.S.C. § 284 (2000).25 Id. § 289.26 Id.; see also Landes Mfg. Co. v. Chromodern Chair Co., 203 U.S.P.Q. 337, 340–41 (C.D. Cal. 1978) (awarding compensatory damages

measured by reference to the patent owner’s lost profits, plus compensatory damages measured by reference to the infringer’s sales and profits plus attorneys fees because the defendant was found to have deliberately copied patented designs for a bar stool and chair); Pac. Furniture Mfg. Co. v. Preview Furniture Corp., 626 F. Supp. 667 (M.D.N.C. 1985), aff’d, 800 F.2d 1111 (Fed. Cir. 1986) (awarding the patent owner three times actual damages against infringer of design patents on chairs and enjoined further infringement of the patents); Schnadig Corp. v. Gaines Mfg. Co., 200 U.S.P.Q. 453,456–57 (W.D. Tenn. 1977), aff’d in part, rev’d in part, 620 F.2d 1166 (6th Cir. 1980) (calculated damages by reference to the infringer’s profits plus attorneys’ fees were awarded where a design patent on an L-shaped sectional sofa was infringed).

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include features such as size, shape, color, or color combinations, texture, [and] graphics.”27 Although most trade dress cases involve simulation of product packaging, protectable trade dress can even consist of the product itself under rare circumstances. Products or parts of products protected under § 43(a) of the Lanham Act have included such widely varying items as fishing reels, lounge chairs, lamps, tables, truck bodies, and kitchen appliances.

The primary source of trade dress law in the United States is the federal Lanham Act, which is generally coextensive with similar state laws governing the competitive process. In keeping with the U.S. policy of encouraging healthy competition and the dissemination of ideas, however, trade dress protection is not available to all designers and manufacturers. Rather, to enjoy the benefits of the Lanham Act and equivalent state laws, trade dress must meet a two-part test to qualify for protection: it must be primarily nonfunctional, and it must possess secondary meaning.

1. The Trade Dress Must be Primarily Nonfunctional

The first element of a successful trade dress infringement claim is a demonstration that the trade dress in question is “nonfunctional.”28 If the trade dress is found to be “functional” by a court, it is eligible only for patent protection. As the Supreme Court has observed, “[I]f a product’s functional features could be used as trademarks . . . a monopoly over such features could be obtained without regard to whether they qualify as patents and could be extended forever (because trademarks may be renewed in perpetuity).”29

The nonfunctionality requirement often is the most difficult obstacle for parties seeking to protect product designs. The fact that an underlying product serves a function, e.g., a chair provides support for sitting individuals, weighs in favor of a finding that the product itself is functional. This does not, however, necessarily render its design ineligible for protection under § 43(a).30 Rather, “[i]n trademark law, ‘functional’ means not that a feature serves a function; it means that the feature is one that competitors would find necessary to incorporate into their product in order to be able to compete effectively.”31 This inquiry requires addressing “whether the trade dress as a whole is functional,” not whether individual features composing the dress are functional.32

To determine whether a claimed trade dress is necessary for effective competition and therefore ineligible for protection, courts typically look at a number of factors. The factor of perhaps greatest significance is the existence of a utility patent bearing on the design, as the Supreme Court has held that the disclosure of a related utility patent is “strong evidence” of the functionality of the underlying

27 Reader’s Digest Ass’n v. Conservative Digest, Inc., 821 F.2d 800, 803 (D.C. Cir. 1987) (citation omitted); see also Two Pesos, Inc. v. Taco Cabana, Inc., 505 U.S. 763, 765 (1992) (recognizing that a Mexican restaurant was entitled to trade dress protection for inter alia “a festive eating atmosphere having interior dining and patio areas decorated with artifacts, bright colors, paintings and murals”); Vaughan Mfg. Co. v. Brikam Int’l Co., 814 F.2d 346, 348 n.2 (7th Cir. 1987) (“A product’s trade dress is the overall image used to present it to purchasers; it could thus include, to give a partial list, the product’s size, shape, color, graphics, packaging, and label.”).

28 See 15 U.S.C. §§ 1125(a)(3), 1125(c)(3)(2006).29 Qualitex Co. v. Jacobson Prods. Co., 514 U.S. 159, 164–65 (1995).30 Fabrication Enters. v. Hygenic Corp., 64 F.3d 53, 55 (2d Cir. 1995) (“The design of a product may serve at least two purposes. It may

identify the source of the product, and it can serve a utilitarian purpose.”).31 Vaughan Mfg. Co. v. Brikam Int’l Co., 814 F.2d 346, 349 (7th Cir. 1987).32 Tools USA & Equip. Co. v. Champ Frame Straightening Equip., Inc., 87 F.3d 654, 658 (4th Cir. 1996).

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device.33 Thus, for example, one case has held that “where a disputed product configuration is part of a claim in a utility patent, and the configuration is a described, significant inventive aspect of the invention, . . . so that without it the invention could not be fairly be said to be the same invention,” the trade dress necessarily is functional and therefore not entitled to protection.34 In another case, a federal appeals court overturned a jury finding of nonfunctionality on the ground that the plaintiff’s claimed trade dress was coextensive with a utility patent covering the same device.35 A plaintiff claiming trade dress protection in a product covered in some manner by a utility patent thus may do so at its peril.36

Another factor that historically has played a significant role in the functionality analysis is the availability of commercially feasible alternative designs.37 Thus, for example, although the inner workings of a fishing reel, e.g., gears, a handle, and line, are necessarily closely similar in all reels, there are a number of alternative shapes for an exterior housing for these elements and therefore a cone-shaped cover may be protected under § 43(a).38 In contrast, however, if there are no alternatives to a particular stove design that create the same heating efficiency, then the design is likely functional and hence unprotectable.39 Likewise, if a particular color makes a particular product feature less obtrusive, it may also be deemed functional, and therefore unprotectable.40

Courts also may consider whether a product’s trade dress allows it to be manufactured more economically than competing alternatives. In one case, for example, the court found that the plaintiff’s “F-style” jug was cheaper to manufacture than other styles and on the basis of this determination concluded that the jug’s shape was functional.41 On the other hand, evidence that alternative designs would cost less to produce weighs strongly in favor of a finding that the trade dress in question is nonfunctional.42

2. The Trade Dress Must Possess “Secondary Meaning”

The second requirement that a product design owner must satisfy is a showing that his or her trade dress is distinctive and therefore distinguishable from that of other producers in the same field.43 A trade dress owner may satisfy the distinctiveness requirement by demonstrating that his trade dress possesses “secondary meaning.” Although the concept of secondary meaning defies easy definition, courts will generally find it to exist if there is evidence that the consuming public associates the trade dress in question exclusively with its owner. Thus, for example, the producer of a distinctively-

33 Se TrafFix Devices, Inc. v. Mktg. Displays, Inc., 532 U.S. 23, 29–30 (2001).34 Vornado Air Circulation Sys., Inc. v. Duracraft Corp., 58 F.3d 1498, 1510 (10th Cir. 1995).35 Elmer v. ICC Fabricating, Inc., 67 F.3d 1571, 1579–80 (Fed. Cir. 1995).36 See In re Telesco Brophey Ltd., 170 U.S.P.Q. 427, 428 (T.T.A.B. 1971) (“[A] utility patent comprehending the configuration in question is

adequate evidence to establish that the configuration is indeed functional in character.”).37 See, e.g., Valu Eng’g, Inc. v. Rexnord Corp., 278 F.3d 1268, 1276 (Fed. Cir. 2002).38 Brunswick Corp. v. Spinit Reel Co., 832 F.2d 513, 519–21 (10th Cir. 1987).39 Fisher Stoves, Inc. v. All Nighter Stove Works, Inc., 626 F.2d 193, 195–96 (1st Cir. 1980).40 Brunswick Corp. v. British Seagull Ltd., 35 F.3d 1527, 1530 (Fed. Cir. 1994).41 Union Carbide Corp. v. Fred Meyer, Inc., 619 F. Supp. 1028, 1032 (D. Or. 1985), aff’d sub nom., First Brands Corp. v. Fred Meyer, Inc.,

809 F.2d 1378 (9th Cir. 1987).42 Sundor Brands, Inc. v. Borden, Inc., 653 F. Supp. 86 (M.D. Fla. 1986).43 See Wal-Mart Stores, Inc. v. Samara Bros., Inc., 529 U.S. 205 (2000).

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shaped trailer bed was successful in protecting its trade dress after presenting surveys demonstrating that consumers recognized trailers with that shape as having been manufactured by the producer.44 Other factors indicating that a particular trade dress has achieved secondary meaning generally include: (1) long and exclusive use by its owner; (2) extensive sales of products featuring it; and (3) evidence of substantial promotional efforts by its owner, in particular promotions that call attention to the trade dress feature sought to be protected.45 Some well-known examples of products that could easily make a showing of secondary meaning are Bose’s Wave Radio and Apple’s ubiquitous iPod music player, both of which are subject to federal trademark registrations for their distinctive product design.

3. Causes of Action Available to Owners of Protectable Trade Dresses

Assuming that a plaintiff can demonstrate that its trade dress is both nonfunctional and a distinctive indicator of origin, there are two primary theories under which it may seek protection.

a) A Likelihood of Confusion Between the Plaintiff’s and the Defendant’s Trade Dress

Although virtually all states have enacted similar provisions, the most important laws by far in the area are §§ 32 and 43(a) of the Lanham Act,46 each of which provides for liability if a defendant has introduced a trade dress that is confusingly similar to the plaintiff’s. Because § 32 is restricted to trade dress owners that have secured federal registrations, the more commonly invoked provision is § 43(a), which provides for liability against:

44 Truck Equip. Serv. Co. v. Fruehauf Corp., 536 F.2d 1210, 1218 (8th Cir. 1976).45 See generally Imagineering, Inc. v. Van Klassens, Inc., 53 F.3d 1260, 1264 (Fed. Cir. 1995); Major Pool Equip. Corp. v. Ideal Pool Corp.,

203 U.S.P.Q. 577, 582–85 (N.D. Ga. 1979).46 15 U.S.C. §§ 1114(1), 1125(a)(1)(A) (2006).

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Any person who, on or in connection with any goods or services, or any container for goods, uses in commerce any word, term, name, symbol, or device, or any combination thereof, or any false designation of origin, false or misleading description of fact, or false or misleading representation of fact, which . . . is likely to cause confusion, or to cause mistake, or to deceive as to the affiliation, connection, or association of such person with another person, or as to the origin, sponsorship, or approval of his or her goods, services, or commercial activities by another person.47

Assuming that a particular trade dress is protectable by virtue of having met the nonfunctionality and distinctiveness requirements set forth above, when may those rights be asserted? As the text of § 43(a) suggests, the standard for determining whether impermissible copying of a trade dress has occurred is whether an appreciable number of ordinarily prudent purchasers will be mislead or simply confused as to the source of the goods in question. Although the precise formulation of the test for determining whether confusion is likely varies from jurisdiction to jurisdiction, courts most frequently consider the following factors:

(1) the fame (or lack thereof) of the trade dress sought to be protected;(2) the similarity of the parties’ trade dresses;(3) the similarity of the products featuring the parties’ trade dresses;(4) the similarity of the parties’ purchasers and channels of trade;(5) the similarity of advertising media used by the parties;(6) the degree of care purchasers are likely to exercise when purchasing the parties’ prod-

ucts;(7) the intent of the subsequent user in adopting its trade dress; and(8) evidence that consumers actually are confused, e.g., consumers purchasing one party’s

goods attempt to return them to the other party.48

Although not essential, a showing of intent to copy a trade dress and/or actual confusion is generally the strongest evidence that confusion is likely.49 Nevertheless, even if these factors are present, it may still be possible in the product configuration context for a defendant to escape liability if it can demonstrate that its use of labeling precludes any consumer confusion as to the source or origin of the product.50

b) A Likelihood to Dilute Distinctiveness

Separate and independent of causes of action (such as that under § 43(a) of the Lanham Act) that depend on a showing of likely confusion, federal law and that of approximately half the states recognize the ability of plaintiffs to protect the distinctiveness of their trade dresses. On October

47 Id. § 1125(a)(1)(A).48 See, e.g., Univ. of Ga. Athletic Ass’n v. Laite, 756 F.2d 1535, 1539, 1542 (11th Cir. 1985); Roto-Rooter Corp. v. O’Neal, 513 F.2d 44, 45

(5th Cir. 1975); In re E.I. Du Pont de Nemours & Co., 476 F.2d 1357, 1361 (C.C.P.A. 1973).49 See, e.g., Sun-Fun Prods., Inc. v. Suntan Research & Dev. Inc., 656 F.2d 186, 190 (5th Cir. 1981).50 See generally Kellogg Co. v. Nat’l Biscuit Co., 305 U.S. 111, 119 (1938); Fisher Stoves, Inc. v. All Nighter Stove Works, Inc., 626 F.2d 193,

195 (1st Cir. 1980); Bose Corp. v. Linear Design Labs, Inc., 467 F.2d 304, 310 (2d Cir. 1972).

shaped trailer bed was successful in protecting its trade dress after presenting surveys demonstrating that consumers recognized trailers with that shape as having been manufactured by the producer.44 Other factors indicating that a particular trade dress has achieved secondary meaning generally include: (1) long and exclusive use by its owner; (2) extensive sales of products featuring it; and (3) evidence of substantial promotional efforts by its owner, in particular promotions that call attention to the trade dress feature sought to be protected.45 Some well-known examples of products that could easily make a showing of secondary meaning are Bose’s Wave Radio and Apple’s ubiquitous iPod music player, both of which are subject to federal trademark registrations for their distinctive product design.

3. Causes of Action Available to Owners of Protectable Trade Dresses

Assuming that a plaintiff can demonstrate that its trade dress is both nonfunctional and a distinctive indicator of origin, there are two primary theories under which it may seek protection.

a) A Likelihood of Confusion Between the Plaintiff’s and the Defendant’s Trade Dress

Although virtually all states have enacted similar provisions, the most important laws by far in the area are §§ 32 and 43(a) of the Lanham Act,46 each of which provides for liability if a defendant has introduced a trade dress that is confusingly similar to the plaintiff’s. Because § 32 is restricted to trade dress owners that have secured federal registrations, the more commonly invoked provision is § 43(a), which provides for liability against:

44 Truck Equip. Serv. Co. v. Fruehauf Corp., 536 F.2d 1210, 1218 (8th Cir. 1976).45 See generally Imagineering, Inc. v. Van Klassens, Inc., 53 F.3d 1260, 1264 (Fed. Cir. 1995); Major Pool Equip. Corp. v. Ideal Pool Corp.,

203 U.S.P.Q. 577, 582–85 (N.D. Ga. 1979).46 15 U.S.C. §§ 1114(1), 1125(a)(1)(A) (2006).

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6, 2006, the Trademark Dilution Revision Act (“TDRA”),51 which amended the Federal Trademark Dilution Act of 1996 (“FTDA”), was enacted. The language of § 43(c) of the Lanham Act now provides that:

[T]he owner of a famous mark that is distinctive, inherently or through acquired distinctiveness, shall be entitled to an injunction against another person who, at any time after the owner’s mark has become famous, commences use of a mark or trade name in commerce that is likely to cause dilution by blurring or dilution by tarnishment of the famous mark, regardless of the presence or absence of actual or likely confusion, of competition, or of actual economic injury.52

The TDRA, among other things, expressly incorporated the “likelihood of dilution” standard for liability, bringing federal law closer to state statutes. For example, under Georgia law:

[A]ll courts having jurisdiction thereof shall grant injunctions to enjoin subsequent use by another of the same or any similar trademark, trade name, label, or form of advertisement if there exists a likelihood of injury to business reputation or of dilution of the distinctive quality of the trademark, trade name, label, or form of advertisement of [a] prior user, notwithstanding the absence of competition between the parties or of confusion as to the source of goods or services [associated with the plaintiff’s designation] . . . .53

Unlike the previous dilution statute, the TDRA expressly provides for trade dress protection against dilution for unregistered trade dress that is nonfunctional and famous.54 Thus, to demonstrate that it is entitled to trade dress protection, a party in a civil action asserting trade dress protection for unregistered trade dress must prove: (1) the claimed trade dress, taken as a whole, is not functional and is famous; and (2) if the claimed trade dress includes any mark or marks registered on the Principal Register, the unregistered matter, taken as a whole, is famous separate and apart from the fame of the registered marks. Section 43(c), as amended, brings the Lanham Act more in concert with state legislation55 and rulings of the Supreme Court, which has held in other contexts that protection for trade dress word marks under the Lanham Act is coextensive with that available for word marks.56 Thus, it is apparent that relief against the introduction of similar product configurations is, at least in theory, available under a dilution theory.57

The ease with which plaintiffs may successfully prosecute a claim for trade dress dilution, however, remains to be seen. As the TDRA expressly states, dilution protection applies to trade dress that is inherently distinctive or has acquired distinctiveness. Most notably, however, the TDRA changed

51 Trademark Dilution Revision Act of 2006, Pub. L. No. 109-312, 120 Stat. 1730 (effective Oct. 6, 2006) (codified at 15 U.S.C.A. § 1125(c)(1) (West Supp. 2008)).

52 15 U.S.C. § 1125(c)(1)(2006).53 O.C.G.A. § 10-1-451(b) (2000).54 15 U.S.C. § 1125(c)(4) (2006).55 Until the 2006 amendments to the Lanham Act, state laws were more broadly worded than the express text of the Lanham Act, and thus,

their reach has long been extended to include product packaging, giving plaintiffs recourse under state law. See, e.g., Robarb Inc. v. Pool Builders Supply of the Carolinas, Inc., 21 U.S.P.Q.2d 1743, 1754–55 (N.D. Ga. 1991), aff’d, 996 F.2d 1231 (11th Cir. 1993).

56 Two Pesos, Inc., 505 U.S. 763, 772.57 See Sunbeam Prods. Inc. v. West Bend Co., 39 U.S.P.Q.2d 1545, 1549, 1555–56 (S.D. Miss. 1996), aff’d, 123 F.3d 246 (5th Cir. 1997).

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the standard set forth by the Supreme Court in Moseley v. V. Secret Catalogue, Inc.,58 now requiring only a likelihood of dilution by blurring or tarnishment rather than proof of actual dilution for injunctive relief.59

Also, protection against dilution is available only to famous designations of origin. Section 43(c) now defines a famous mark as one that is “widely recognized by the general consuming public of the United States,”60 and sets forth guidelines for determining whether a designation of origin is sufficiently famous to warrant protection:

In determining whether a mark possesses the requisite degree of recognition, the court may consider all relevant factors, including the following:

(i) [t]he duration, extent, and geographic reach of advertising and publicity of the mark, whether advertised or publicized by the owner or third parties.

(ii) [t]he amount, volume, and geographic extent of sales of goods or services offered under the mark.

(iii) [t]he extent of actual recognition of the mark.

(iv) [w]hether the mark was registered under the Act of March 3, 1881, or the Act of February 20, 1905, or on the principal register.61

Assuming that its trade dress is sufficiently famous to warrant protection against dilution, a plaintiff may prevail by making one of two showings. First, the plaintiff may demonstrate impermissible dilution if the defendant has utilized a similar trade dress in a manner that is likely to “tarnish” the fame associated with the plaintiff’s dress.62 Second, and probably far more likely in the product configuration context, a plaintiff may demonstrate that the defendant’s introduction of a similar product shape is likely to “blur,” or “whittle down,” the distinctiveness of the plaintiff’s trade dress.63 Under this theory of relief, “[e]ven though there may be no confusion, the distinctiveness of a famous [trade dress] may be debilitated by another’s use and this is the essence of the wrong.”64 As a practical matter, however, relief against dilution under federal law may be difficult to secure for most product design owners, and the case law applying the revised standards of the TDRA is still in its infancy.

B. Federal Registration of Trade Dresses

As set forth above, a design owner seeking to bring suit against an infringer under § 43(a) must first prove that its trade dress is, in fact, protectable, i.e., that it is nonfunctional and viewed by the public as a distinct identifier of origin for his goods. If, however, he believes that he can prove these elements

58 537 U.S. 418, 432–33 (2003), superseded by statute, 15 U.S.C. § 1125(c)(1).59 15 U.S.C. § 1125(c)(1) (2006).60 Id. § 1125(c)(2)(A) (2006) 61 Id..62 See, e.g., Pillsbury Co. v. Milky Way Prods., Inc., 215 U.S.P.Q. 124, 134–35 (N.D. Ga. 1981).63 Original Appalachian Artworks, Inc. v. Topps Chewing Gum, Inc., 642 F. Supp. 1031, 1039 (N.D. Ga. 1986).64 Augusta Nat’l, Inc. v. N.W. Mut. Life Ins. Co., 193 U.S.P.Q. 210, 221 (S.D. Ga. 1976).

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prior to being faced with infringement by another party, he should consider applying to register his trade dress with the PTO in the same way that a word mark or logo may be registered. Taking this precautionary step often can dramatically increase the chances of success in later litigation.

Applications for federal trade dress registrations are subject to various technical requirements. In brief, once the PTO has received an application, it grants a filing date to the applicant. The application then is reviewed by an examining attorney to determine registrability, including conflicts with existing registrations.65 If the examining attorney refuses an application, the applicant may respond in writing.66 If the objection is overcome, the application is published in the PTO’s Official Gazette, after which other parties who also may be using the same or a similar design will be given the chance to oppose the application.67 If the objection is not overcome, or if another party opposes the application, the applicant has the opportunity for administrative and judicial appeal.68

The federal government keeps two different lists, or “registers,” on which trademarks, service marks, and trade dresses may be registered: the Principal Register and the Supplemental Register.

1. The Principal Register

The Principal Register is reserved for marks and trade dresses whose owners can demonstrate nonfunctionality and distinctiveness at the time they file their application. For example, although trademark registration of an ice cream cone design for a “container for holding baby pants” was initially refused, the PTO subsequently found that “if a label which is inherently distinctive is registrable on the Principal Register, a package inherently distinctive is similarly registrable.”69 Additionally, The Coca-Cola Company was able to register on the Principal Register its distinctively fluted bottle design and McDonald’s its Golden Arches, after years of advertising drawing attention to these features created secondary meaning for them.

If these two requirements can be established—and assuming there are no conflicts with existing registrations—the ensuing registration of a trade dress on the Principal Register confers a number of benefits on its owner. These include:

a) Use of the ® Symbol and Other Notices

Federal registration entitles the registrant to use the distinctive ® symbol in connection with his mark or trade dress, as well as the notations “Registered in U.S. Patent and Trademark Office” and “Reg. U.S. Pat. & Tm. Off.”70 Because prominent affixation of these notices often is impractical in the case of products that depend on an attractive appearance for their sale, a trade dress owner with a federal registration alternatively may choose to place on his packaging a legend such as “The trade dress of the enclosed product is a federally registered trademark.” These notices alone often provide a significant deterrent to copying.

65 See generally Glenwood Labs., Inc. v. Am. Home Prods. Corp., 455 F.2d 1384, 1387 (C.C.P.A. 1972).66 See 15 U.S.C. § 1062 (2006).67 37 C.F.R. § 2.80 (2008).68 See 15 U.S.C. §§ 1070–71 (2006); 28 U.S.C. § 1295 (2000).69 In re Int’l Playtex Corp., 153 U.S.P.Q. 377, 377–78 (T.T.A.B. Apr. 13, 1967).70 15 U.S.C. § 1111 (2006).

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b) Constructive Notice

Another important benefit of a federal registration is that it provides “constructive notice” of the registrant’s use of its trade dress.71 That is to say, because federal law assumes that all designers in the country have access to the Principal Register and will consult it prior to beginning use of their own designs, a subsequent user of a registered trade dress cannot escape liability for infringement by claiming that he was unaware of the registrant’s prior rights.72

c) Evidentiary Presumptions

Ownership of a registration on the Principal Register for a particular product design also makes the registration “prima facie” evidence that the trade dress is distinctive (whether inherently distinctive or possessed of secondary meaning) and nonfunctional.73 Thus, in contrast to actions to protect unregistered trade dress under § 43(a), in which the burden is on the first user to prove that his trade dress meets these requirements, the burden to prove otherwise can shift to the allegedly infringing party in actions to protect registered trade dresses.74

Moreover, after the fifth anniversary of the issuance of a registration, its owner may move the PTO to declare the registration “incontestable.”75 At this point, the registration becomes “conclusive” evidence of its owner’s rights to the trade dress covered by the registration.76 The owner of an incontestable registration, therefore, no longer needs to demonstrate at all that its trade dress is either inherently distinctive or has secondary meaning.77 In addition, the mere fact that a registration has passed its fifth anniversary also has the effect of preventing a defendant in an infringement action from challenging the registration by claiming prior use of the trade dress.78 Incontestability, however, does not foreclose challenges on certain grounds, including functionality, fraud, abandonment, and certain equitable principles (including laches, estoppel, and acquiescence).79

2. The Supplemental Register

In part because trade dress owners frequently were and are unable to meet the requirement for registration on the Principal Register that their trade dresses are either inherently distinctive or have secondary meaning, the Lanham Act also established the Supplemental Register. In contrast to the strictures of the Principal Register, an applicant seeking registration on the Supplemental Register need only demonstrate that its trade dress: (1) is capable of acquiring secondary meaning (but not

71 Id.72 Mesa Springs Enters., Inc. v. Cutco Indus., Inc., 736 P.2d 1251, 1253 (Colo. Ct. App. 1986).73 15 U.S.C. §§ 1057(b), 1115(a) (2006)74 See generally Aromatique, Inc. v. Gold Seal, Inc., 28 F.3d 863, 869 (8th Cir. 1994); Mech. Plastics Corp. v. Titan Techs., Inc., 823 F. Supp.

1137, 1145 (S.D.N.Y. 1993), aff’d without op., 33 F.3d 50 (2d Cir. 1994).75 15 U.S.C. § 1065 (2006).76 See id. § 1115(b); see also Park ‘N Fly, Inc. v. Dollar Park and Fly, Inc., 469 U.S. 189, 196, 205 (1985).77 See, e.g., Kransco Mfg., Inc. v. Hayes Specialties Corp., 33 U.S.P.Q.2d 1999, 2001 (E.D. Mich. 1994), aff’d in part, vacated in part, 77

F.3d 503 (Fed. Cir. 1996).78 See 15 U.S.C. § 1064(3) (2006).79 Id. § 1115(b)(1)–(9) (2006).

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that the trade dress necessarily has done so); and (2) was in use prior to the time that the applicant filed its application.80

Although obtaining a registration on the Supplemental Register is significantly easier than doing so on the Principal Register, the benefits of registration are correspondingly reduced. For example, the owner of a registration on the Supplemental Register does not enjoy the evidentiary presumptions set forth above. The owner does, however, have the right to affix notices of the registration to its product or its packaging. Moreover, after five years of substantially exclusive and continuous use of his mark or trade dress, the owner can amend its registration to the Principal Register even in the absence of a showing that its trade dress has achieved secondary meaning.81

C. Available Remedies to Successful Trade Dress Infringement Plaintiffs

Once a trade dress owner has established infringement, such a finding gives rise to a variety of equitable and monetary remedies. These typically include: (1) recovery of all or a portion of the infringer’s profits; (2) compensation for any damages sustained by the trade dress owner; and (3) recovery of the costs of legal proceedings. In addition, the court may award up to treble damages and, in exceptional cases, recovery of attorneys’ fees to the prevailing party. These remedies are available not only for trade dress infringement, but also for federal unfair competition or false advertising under § 43(a).82

III. Copyrights

This section deals with the extent to which the configuration of a product may be eligible (or ineligible) for copyright protection.

A. Proving Nonfunctionality for Product Design Under Copyright Law

Would-be copyright owners face the same hurdle of proving that their designs are nonfunctional as do designers seeking trade dress protection.83 Consequently, although the design of a useful article can be subject to copyright protection to the extent that its pictorial, graphic, or sculptural features can be identified as existing independently of the utilitarian object, designs for useful articles, such as vehicular bodies, boat hulls, wearing apparel, household appliances, and the like typically are not protectable by copyright. As Congress noted of these types of useful articles in passing the bill that became the 1976 Copyright Act:

[A]lthough the shape of an industrial product may be aesthetically satisfying and valuable, the Committee’s intention is not to offer it copyright protection under the bill. Unless the shape of an automobile, airplane, ladies’ dress, food processor, television set, or any other industrial product contains some element that, physically or conceptually, can be identified as separable from the utilitarian aspects of that article, the design would not be copyrighted under the bill. The test of separability and independence from “the utilitarian aspects of

80 Id. § 1091.81 Id. § 1052(f).82 Id. §§ 1116, 1117.83 See 17 U.S.C. § 101 (2006).

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the article” does not depend on the nature of the design—that is, even if the appearance of an article is determined by esthetic [sic] (as opposed to functional) considerations, only elements, if any, which can be identified separately from the useful article as such are copyrightable. And, even if the three-dimensional design contains some such element (for example, a carving on the back of a chair or a floral relief design on silver flatware), copyright protection would extend only to that element, and would not cover the over-all configuration of the utilitarian article as such.84

Applications of this standard have reached varying results. At one end of the spectrum are cases involving copyrighted features that clearly are unrelated to the underlying functional nature of the product in question. For example, although a manufacturer ordinarily would be unable to monopolize particular items of furniture, the pattern on decorative upholstery generally is protectable.85

A more difficult case arises if the feature sought to be protected is necessary to the functioning of the underlying product. For example, one applicant to the Copyright Office was refused registration for its “artistic design for lighting fixtures” after the Register of Copyrights determined that the application encompassed the entire lighting assembly, including the base, housing, electrical fixture, and light bulb. Although on the applicant’s appeal the court of appeals acknowledged that the applicant might have been entitled to protection had it only sought to protect the external housing of its fixture, the court nevertheless held that the applicant’s claim to the other purely utilitarian features precluded registration of its design.86

If, however, a designer seeks only to protect nonfunctional embellishments of an underlying product, his chances of success are considerably greater. In the first major case to arise in the design copying area under the 1976 Copyright Act, the plaintiff sought to protect belt buckles featuring alternating raised and depressed areas allegedly creating a unique artistic work. The defendant sought to escape liability by arguing that the claimed purely decorative elements of the buckle would fall apart if the functional elements were removed. The court, however, rejected the defendant’s argument that the features sought to be protected had to be capable of existing independently of the utilitarian aspects of the article. Rather, the court relied on the congressional committee language quoted above to hold that the features were copyrightable if they were merely conceptually separable.87

Not surprisingly, the distinction between functional and nonfunctional works can produce varying results. In one case involving the alleged copying of a drawer pull for furniture, for example, the court held that the defendants could not be held liable for copyright infringement if they had copied the functional three-dimensional drawer pull itself. Nevertheless, the court concluded, the defendants could be held liable if they had manufactured their pull by copying the plaintiff’s copyrighted two-dimensional (and presumably nonfunctional) plans.88

84 H.R. Rep. No. 94-1476, at 55 (1976), reprinted in 1976 U.S.C.C.A.N. 5659, 5668.85 See, e.g., Collins & Aikman Corp. v. Carpostan Indus., Inc., 720 F. Supp. 561, 564–66 (D.S.C. 1989), aff’d, 905 F.2d 1529 (4th Cir. 1990).86 Esquire, Inc. v. Ringer, 591 F.2d 796, 806 (D.C. Cir. 1978).87 Kieselstein-Cord v. Accessories by Pearl, Inc., 632 F.2d 989, 993–94 (2d Cir. 1980).88 Keeler Brass Co. v. Cont’l Brass Co., 862 F.2d 1063, 1066 (4th Cir. 1988).

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B. Prosecuting Copyright Infringement Suits

A designer seeking to protect his design through copyright law generally must meet two criteria. First, he must demonstrate that he holds a valid copyright and a valid copyright registration in the material sought to be protected. Second, he must demonstrate copying by the defendant what are the requirements for demonstrating impermissible copying.89

As defendants rarely will admit that they have copied a plaintiff’s copyrighted work, courts generally have accepted circumstantial evidence to create a presumption of copying. To raise this presumption, the plaintiff must show that the alleged copier had access to the copyrighted design and that the original design and the alleged copy are “substantially similar.”90 In keeping with the general presumption underlying U.S. law that copying of ideas is to be encouraged except under relatively limited circumstances, however, the fact that a defendant may have intended to come as close as possible to a copyrighted design is irrelevant to a determination of whether two works are “substantially similar.” Rather, as one court has observed:

“Copying” is a concept without statutory definition. Those courts which have had occasion to consider the issue distinguish between copying an idea and the expression of that idea. Only the latter constitutes infringement. Even if the defendant has sedulously borrowed each of the plaintiffs’ ideas, that alone is not violative of the copyright statute. The plaintiff can only prevail if the overall aesthetic impressions created by the designs are substantially the same.91

Consequently, there is no “copying” in the absence of substantial similarity, even if the accused designer intended to create a design similar to that of the copyright owner.92

Moreover, even if the plaintiff can succeed in establishing access and substantial similarity, these showings create only the presumption that impermissible copying has occurred. If the defendant fails to introduce evidence to the contrary, the plaintiff will prevail. But the defendant still may defeat this presumption by a showing that he created his design separately and independently of the plaintiff’s design.93 If the defendant can do so, the presumption in the plaintiff’s favor vanishes and the case typically will boil down to a so-called “swearing contest,” decided according to the court’s view of whose account of the creation of the allegedly infringing design is more credible.

C. Remedies for Copyright Infringement

A successful copyright plaintiff potentially may enjoy a variety of remedies. Like a successful trade dress plaintiff, he is entitled to an injunction against further copying that is “reasonable to prevent or restrain infringement,”94 as well as his damages and the defendant’s profits, to the extent that

89 See generally Benson v. Coca-Cola Co., 795 F.2d 973, 974 (11th Cir. 1986).90 Keeler Brass, 862 F.2d at 1065.91 Manes Fabrics Co. v. Miss Celebrity, Inc., 246 F. Supp. 975, 977 (S.D.N.Y. 1965) (citations omitted).92 See, e.g., Condotti, Inc. v. Slifka, 223 F. Supp. 412, 415 (S.D.N.Y. 1963).93 See, e.g., Sheldon v. Metro-Goldwyn Pictures Corp., 81 F.2d 49, 54 (2d Cir. 1936).94 17 U.S.C. § 502(a) (2006).

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those profits are not included in the plaintiff’s damages.95 Similarly, the court also may order all unauthorized copies of the plaintiff’s design to be seized and destroyed.96

A successful copyright plaintiff who registered his copyright prior to the defendant’s infringing actions has the option of recovering “statutory damages” in lieu of actual damages and profits. Depending on how egregious the defendant’s actions were in infringing the plaintiff’s design, these damages may range from $750 to $30,000.97 Where the court finds that the infringement was committed willfully, it may award up to $150.000.98 Plaintiffs in this class may also be entitled to costs and attorneys’ fees.99

IV. Trade Secrets

Trade secrets are information used in a trade or business and known only to the user.100 Although a classic trade secret is a formula or secret recipe, various types of information can have the status of a trade secret under the right circumstances, including information about costs or sources of supply, manufacturing processes, and even not-yet-revealed business plans.101 Because information that can be determined by examining a publicly-available product generally cannot be a trade secret, relatively few trade secrets are embodied in products or product designs that are on the market.102 Even for businesses that sell products that are easily “reverse engineered,” once they are on the market, trade secret protection can be valuable in connection with products not yet introduced to the market, both in keeping competitors in the dark and to insure that potential patent rights are not lost.

State laws, rather than federal laws, protect against the misappropriation and improper use of trade secrets.103 Those laws can be invoked if a competitor breaks into the company’s safe to steal the secret formula, but they more often come into play when an employee goes to work for a competitor and discloses or uses trade secrets of his former employer. Successful invocation of trade secret

95 Id. §§ 504–05.96 Id. § 503.97 Id. § 504(c)(1).98 Id. § 504(c)(2).99 Id. § 505. 100 See, e.g., restateMent (third) of Unfair coMpetition § 39, at 425 (1995).101 Georgia has statutorily defined trade secrets very broadly:

“Trade secret” means information, without regard to form, including, but not limited to, technical or non-technical data, a formula, a pattern, a compilation, a program, a device, a method, a technique, a drawing, a process, financial data, financial plans, product plans, or a list of actual or potential customers or suppliers which is not commonly known by or available to the pubic and which information:

(A) Derives economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and

(B) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.O.C.G.A. § 10-1-761(4) (2000).102 The best known exception is the Coca-Cola formula, which is supposedly still a trade secret despite public availability of the product for

more than 100 years.103 The law of trade secrets is part of the “judge-made” or common law inherited from England and extensively further developed in the

United States. Many states have also adopted “legislature-made” statutes relating to trade secrets. Quite a few have adopted a version of the Uniform Trade Secrets Act. Despite the existence of fifty separate bodies of trade secret law, there is substantial uniformity in trade secret principles throughout the United States.

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rights can result in the award of damages and issuance of an injunction preventing the continued use of misappropriated trade secrets.

The law will protect trade secrets only if the owner has taken appropriate measures to prevent disclosure. Accordingly, planning is important to maintain the possibility of using trade secret principles to protect product designs, methods of manufacture, or other aspects of a business activity that may appropriately be accorded protection. The most important planning is simple communication with employees of the business about the importance of protecting its confidential information. Employee confidentiality agreements are often important both in communicating to employees the need to protect trade secrets and in establishing legally protectable rights. Such agreements also typically include provisions establishing the employer’s ownership rights with respect to inventions and copyrightable works created by employees in the course of their employment. Many employers require each of their employees to sign such agreements, and virtually every business that may have trade secrets or other confidential information, or whose employees may invent or create copyrightable works in the course of their employment, should utilize such agreements.

V. Conclusion

Only relatively narrow exceptions to the general rule—that competition should be unfettered—are available to prevent design copying. Such copying nevertheless frequently can be stopped or at least limited, and with appropriate planning and timely efforts to establish intellectual property rights, very substantial barriers to such copying can be established. For those who follow the legally encouraged practice of copying existing product designs, understanding of the prohibitions on such copying can avoid conflict.

Curiously, many business people who would never base other critical business decisions, like ones relating to tax planning or accounting matters, on the advice of amateurs routinely draw conclusions about the protectability of designs and the possibility of stopping copying (or that their own copying can be stopped) without accurate information. Those who base business decisions relating to intellectual property on facts rather than myths, however, enhance the likelihood of long term business success.

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EXCERPTS FROM EXAMPLES OF DESIGN AND UTILITY PATENTS

Design patents can protect the appearance of chairs:

a building to house an automatic bank teller machine:

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a restaurant building:

a cardboard container:

a shoe:

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a shoe sole:

a portable computer:

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and a woodworking tool called a mortise marking gauge:

Utility patents have been granted to protect

the structure or function of a knock-down furniture fitting:

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a commercial shelving support structure:

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a patternmaker’s vise:

and a fixture for making bent wood laminations, such as those used in millwork:

gn.

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

PATENT

Reexamination Tactics: Present and Future

Mitchell G. Stockwell and Bonnie M. Grant

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Reexamination Tactics: Present and FutureMitchell G. Stockwell and Bonnie M. Grant

I. Introduction

Patent litigation belies the notion of cost-effective, efficient patent dispute resolution. Typical costs range from $500,000 and $4,000,000 to litigate a patent dispute to judgment. Like any complex commercial dispute, these costs are driven in large part by attorneys’ fees, expert witness fees, discovery costs, trial exhibits, etc. That these costs multiply so swiftly in patent litigation partly stems from the many complex technical and legal issues—chief among them patent infringement and validity—parties must investigate, assert, or defend.

These dispute resolution costs help drive the vast majority of cases to settlement. Such frequent settlements suggest that while counsel must prepare a case for trial, it is at least as important to prepare for settlement.

One method of preparing for both settlement and litigation is to narrow the disputed issues with reexamination. Reexamination entails the United States Patent and Trademark Office (“PTO”) considering whether certain types of “prior art,” technical information available before the invention, raise a substantial new question of patentability. This provides the PTO’s view of the impact of the prior art on patent claim validity. That view (after any appeal) is dispositive when claims are rejected; when original or amended claims are upheld, however, the PTO’s decision following reexamination is highly relevant evidence of validity that a court must consider. These reexamination results allow counsel for a patent owner or accused infringer to prepare a case for trial and simultaneously generate important settlement leverage and options—at a bargain basement price in comparison with trying validity to a court or jury.

This article describes present reexamination practice, the effect of a reexamination proceeding on pending, anticipated, or subsequent litigation, and practical reexamination tactics.

II. Reexamination Practice

Reexaminations may be inter partes or ex parte. Inter partes reexamination is available for patents issuing from original applications filed in the U.S. on or after November 29, 1999. In general, inter partes reexamination allows a great amount of participation by third party requestors. Under inter partes reexamination, third party requestors may file comments responding to the patent owner’s responses to office actions. Additionally, third party requestors may appeal decisions by the PTO upholding patentability. Under inter partes reexamination, however, the “real party in interest” must be identified, and third party requestors may be estopped under § 315(c) from making certain arguments in subsequent litigations. From 2003 to 2007, inter partes requests increased by 600%.1 More than half of patents in inter partes reexaminations are known to be in litigation during reexamination.2

1 Institute for Progress, Reexamining Inter Partes Reexam (April 2008), available at http://blog.patentassassins.com/up-content/uploads/2008/05/interpartesreexamwhitepaper.pdf.

2 Id.

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Ex parte reexamination allows significantly less participation by the third party requestor. In general, after the PTO issues an ex parte order for reexamination, the third party requestor cannot participate in the proceedings further. From 2002 to 2003, ex parte requests increased by 70%. In 2003, there were 392 requests filed for ex parte reexamination, and of those, 109 requests are known to have related litigation.

A. Persons Who May Request and Participate in Reexamination

“Any person at any time may file a request for reexamination” of a patent—and they may do so anonymously if they file for ex parte reexamination.3 But courts cannot order persons to file reexamination requests.4 Nor can a court compel a patent owner to submit documents from some third party with the patent owner’s submissions during the ex parte phase of reexamination proceedings.5

B. Contents of the Request

Each ex parte reexamination request must include (1) a statement pointing out each substantial new question of patentability; (2) an identification of every claim for which reexamination is requested and a detailed explanation of how the cited prior art applies to each such claim; (3) copies of the prior art and the patent for which reexamination is requested; (4) a fee; and (5) “[a] certification that a copy of the request filed by a person other than the patent owner has been served in its entirety on the patent owner.”6 In addition to these requirements for submitting an ex parte request for reexamination, inter partes requests for reexamination must include: (6) “[a] certification by the third party requestor that the estoppel provisions of § 1.907 do not prohibit the inter partes reexamination;” and (7) “[a] statement identifying the real party in interest to the extent necessary for a subsequent person filing an inter partes reexamination request to determine whether that person is a privy.”7 Requesters who own the patent also may describe why claims remain patentable despite the prior art cited in the request.8 Also, the examiner may consider patents or printed publications in addition to those cited in the request.

The most significant substantive portion of the request is the cited prior art and the characterization of that art. The request must be based on “prior art consisting of patents or printed publications.”9 Under ex parte reexamination, however, admissions by the patent owner about matters affecting patentability may be used in combination with a patent or printed publication.10 These content restrictions reflect the limitations of the PTO, which is not generally equipped to hear or weigh

3 35 U.S.C. § 302 (2000); U.S. Dep’t of CommerCe, U.S. patent & traDemark offiCe, manUal of patent examining proCeDUre § 2212 (8th ed. rev. 7 2008) [hereinafter MPEP]; see also Parker Hannifin Corp. v. Davco Mfg. Corp., 13 U.S.P.Q.2d 1412 (N.D. Ohio 1989) (refusing to compel discovery on whether a party in litigation requested reexamination of the patent in suit).

4 In re Cont’l Gen. Tire, Inc., 81 F.3d 1089 (Fed. Cir. 1996).5 Emerson Elec. Co. v. Davoil, Inc., 88 F.3d 1051 (Fed. Cir. 1996).6 37 C.F.R. § 1.510(b)(5) (2008). The present reexamination fee is $2,520 (ex parte) or $8,800 (inter partes), but is subject to change (usually

upward). Id. § 1.20(c). If a reexamination proceeding is not instituted, a partial fee refund will be made. See id. § 1.26.7 Id. § 1.915(b)(8).8 Id. § 1.530(c).9 35 U.S.C. § 301 (2000); 37 C.F.R. § 1.501(d) (2008). Patent owners—but no others—desiring consideration of issues like prior public

uses or sales may file a reissue application. 35 U.S.C. § 251 (2000).10 MPEP, supra note 3, § 2217; see also Ex parte McGaughey, 6 U.S.P.Q.2d 1334 (Bd. Pat. App. & Int. 1988).

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testimony or apply rules of evidence to admissibility of evidence about prior art not described in patents, printed publications, or a clear record.

Perhaps of more significance, a request may include affidavits or declarations explaining the content or dating the prior art.11 Such written testimony provides an excellent mechanism for providing persuasive expert testimony to the PTO about the prior art—either describing how it renders the invention unpatentable or how the invention differs from or improves over the prior art. Also, requesters may present evidence, including such affidavits or declarations “that claims in the patent for which reexamination is requested are . . . not supported by an earlier . . . application whose filing date is claimed.”12 With this procedure, “intervening” patents or printed publications that are dated earlier than the patent’s actual filing date, but not dated earlier than the patent’s earliest filing date, may be used as prior art.13

Moreover, while public use prior art cannot be considered on its merits within a reexamination proceeding, patent challengers must be careful not to overlook other, allowable uses for such evidence in reexamination. For example, that evidence bears on “secondary considerations” and the level of skill in the art, factors established by the Supreme Court as pertinent to whether inventions are obvious.14 Evidence that the invention was publicly known, used, or sold in the United States by third parties may indicate obviousness by showing the “trial and success” of others.15 Also, such evidence shows that the skill level in the relevant art sufficed to render the invention obvious to artisans of ordinary skill.16

C. The Standard for Granting Reexamination

All the evidence submitted in the request aims to answer the question: Does the cited prior art present a substantial new question of patentability? For challengers seeking to cancel or narrow patent claims, the answer is “yes” far more often than will be the answer to the corresponding question in litigation: Does the prior art invalidate the claim? Indeed, the low threshold for initiating a reexamination makes it difficult for patent owner requesters to persuade the PTO that no reexamination need be ordered. Indeed, one recent statistic indicates that the PTO grants 95% of inter partes reexamination requests.17

If available, the examiner who originally handled the patent application will decide the request within at most three months. This is good news for patent owners—reexamination by the same examiner issuing the patent probably heightens the chance that original or amended claims will be confirmed.

11 MPEP, supra note 3, § 2218.12 Id.13 Id.; see also In re Ruscetta, 255 F.2d 687 (C.C.P.A. 1958).14 Graham v. John Deere Co., 383 U.S. 1 (1966). 15 See, e.g., In re Merck & Co., 800 F.2d 1091, 1098 (Fed. Cir. 1986); Am. Standard, Inc. v. Pfizer Inc., 722 F. Supp. 86, 139 (D. Del. 1989).16 See, e.g., Newell Cos. v. Kenney Mfg. Co., 864 F.2d 757, 766 n.2 (Fed. Cir. 1988); Felburn v. N.Y. Cent. R.R. Co., 350 F.2d 416, 424 (6th

Cir. 1965). 17 Institute for Progress, supra note 1.

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D. Proceedings After Grant of the Request

Upon finding a substantial new question of patentability, the examiner assigned to the proceeding orders reexamination of the claim(s) to resolve that question. For ex parte reexaminations, the order granting reexamination will generally set a two-month time period in which the patent owner may file an optional statement and amendment refuting the substance of the request, amending original claims, or adding new claims.18 If the patent owner files a statement and/or amendment, the third party requestor may file a reply.19 In inter partes reexamination, however, the order granting reexamination “will usually be accompanied by the initial office action on the merits.”20

In ex parte reexamination, after any statement or reply, the proceeding enters the prosecution stage, during which the examiner may reject the claims being reexamined or any new proposed claims.21 While the patent owner may file amendments and arguments responsive to any rejections, a third party requester cannot participate in the prosecution stage.22 Similarly, a patent owner can appeal a rejection, but a third party requester has no appeal rights.23 In inter partes reexamination, however, a third party requester may file comments to every response filed by the patent owner to an office action on the merits.24 Additionally, third party requesters may appeal decisions favorable to patentability.25

Patents in reexamination are not presumed valid.26 Indeed, third party challengers or the PTO need only prove that a particular claim is unpatentable by a preponderance of the evidence.27 This burden is made even lighter given that the PTO gives the claims being reexamined their broadest reasonable interpretation consistent with the patent’s specification.28 In ex parte reexamination, these procedural advantages may help a third party challenger overcome the fact that patent owners have multiple chances (through amendment, new claims, personal interviews with the examiner or an appeal) to chip away at an examiner’s resolve to reject claims.

Once ordered, reexamination proceeds to conclusion. A recent survey indicates that the pendency period for reexaminations without appeal is between 34 and 53 months, while the PTO’s own statistics report a pendency of about 28 months.29 The survey authors have critiqued the PTO’s

18 37 C.F.R. § 1.530 (2008).19 Id. § 1.535.20 Id. § 1.935.21 Although new claims may be added and original claims amended, they cannot be broader than the original issued claims, or they are

invalid under 35 U.S.C. § 305. See Quantum Corp. v. Rodime, PLC, 65 F.3d 1577, 1580 (Fed. Cir. 1995); Thermalloy Inc. v. Aavid Eng’g, Inc., 935 F. Supp. 55 (D.N.H. 1996), aff’d, 121 F.3d 691 (Fed. Cir. 1997).

22 MPEP, supra note 3, § 2254.23 MPEP, supra note 3, §2273.24 37 C.F.R. § 1.947 (2008).25 Id. § 1.953.26 In re Etter, 756 F.2d 852 (Fed. Cir. 1985).27 Ethicon, Inc. v. Quigg, 849 F.2d 1422, 1427 (Fed. Cir. 1988).28 In re Yamamoto, 740 F.2d 1569 (Fed. Cir. 1984). By contrast, claims under attack in litigation are “construed, if possible, to sustain their

validity.” Id. at 1571 n.1.29 Institute for Progress, supra note 1.

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statistics as misleading.30 At its completion, the PTO issues a certificate confirming original or amended claims and canceling unpatentable ones.

A recent informal survey taken by Kilpatrick Stockton among registered patent attorneys comparing the two types of reexamination proceedings found that the quality of inter partes reexaminations is higher. Participants who had used both types of proceedings favored inter partes over ex parte. Participants said that the most serious flaws in any reexamination proceeding included the inability to raise evidence of public use prior art; the fact that there are no examiner interviews; and the estoppel provisions of reexamination proceedings.

III. The Effects of Reexamination

A. On Pending or Anticipated Litigation

If related litigation on the patent is pending, courts may grant motions to stay the litigation or dismiss it without prejudice until the reexamination proceeding concludes.31 For instance, the court will typically grant stay requests that are filed before discovery proceeds substantially, given the typical court’s desire to obtain the expert view of the PTO and, as a practical matter, to get rid of a potentially complex patent case. Stays also make sense from the perspective of judicial efficiency—there is little reason to determine validity or infringement of claims that may soon be canceled or narrowed. If the court stays related litigation, the PTO will further expedite reexamination proceedings.

Despite the good odds that a court will stay litigation in favor of reexamination proceedings, nothing precludes patent owners from suing on a patent already in reexamination. For patents that already have survived reexamination or that are in reexamination but have received an indication of allowance from the PTO, patent owners may be able to establish more readily the factors necessary for a preliminary injunction.32

B. On Later District Court Proceedings

Much ink has been spilled on what effect a prior reexamination proceeding has when claims are rechallenged in subsequent litigation. A summary of the law might read as follows: Confirmation of patent claims following a reexamination proceeding effectively “strengthens” their statutory presumption of validity. Although reexamination does not bind a court as to validity questions,33 it greatly increases a defendant’s burden of establishing the invalidity of a reexamined patent in

30 Id.31 See generally Steven M. Auvil, Note, Staying Validity Litigation Pending Reexami nation: When Should Courts Endeavor To Do So?,

41 Clev. St. l. rev. 315 (1993); but see Standard Havens Prods., Inc. v. Gencor Indus., Inc., 953 F.2d 1360, 1366 n.2 (Fed. Cir. 1991) (declining to stay proceedings in view of reexamination despite the Board’s approval of rejection); Arthrocare Corp. v. Smith & Nephew, Inc., 315 F. Supp. 2d 615, 619-20 (D. Del. 2004) (denying accused infringer’s motion to stay injunction pending appeal because of pending reexamination proceedings on the adjudicated patents); Eolas Tech. Inc. v. Microsoft Corp., 70 U.S.P.Q.2d 1939 (N.D. Ill. Jan. 15, 2004) (denying motion to stay entry of judgment in view of reexamination); NTP, Inc. v. Research in Motion, Ltd., No. Civ. A. 3:01CV767, 2003 WL 23100881 (E.D. Va. Aug. 5, 2003) (denying as moot RIM’s motion to stay pending director initiated reexaminations and entering judgment).

32 See, e.g., Am. Permahedge, Inc. v. Barcana, Inc., 857 F. Supp. 308 (S.D.N.Y. 1994); Auto. Prods. PLC v. Fed. Mogul Corp., 11 U.S.P.Q. 2d 1471 (E.D. Mich. 1989).

33 Gen. Elec. Co. v. Hoechst Celanese Corp., 740 F. Supp. 305, 312 (D. Del. 1990).

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view of the same art considered in reexamination.34 For example, in assessing validity, courts must consider the fact that the PTO upheld the patent in reexamination.35

But courts should defer to PTO findings following reexamination only “with respect to the evidence and prior art that was before both the PTO examiners and the court.”36 Thus, the PTO’s failure to address invalidity for “obviousness” may allow a defendant to argue that the court should consider obviousness independently.37 Likewise, no heightened burden applies if prior art not previously before the PTO is used to show invalidity.

These rules generally make sense. The whole reason for a “heightened” validity presumption following reexamination is that the PTO has confirmed claims despite the cited prior art. When the same or similar evidence is used in subsequent litigation, the fact finder is entitled to presume that the PTO did its job in reviewing that evidence, thus forcing the attacker “to show that the PTO was wrong in its decision to grant the patent.”38 Although this is a higher burden, it is not impossible to meet. On the other hand, if significantly new evidence or testimony is presented in later litigation, the PTO’s failure to consider such evidence indicates no heightened presumption should apply.

Reexamination may impact more issues than whether a party’s patent is invalid in view of prior art patents or printed publications. Thus, even though infringement and inequitable conduct issues are not directly considered by the PTO during reexamination, reexamination proceedings may have an impact on how a court or jury subsequently views those issues.

A party challenging the validity of a patent through a reexamination proceeding obviously seeks to have patent claims canceled; such canceled claims cannot be infringed. Even if, however, this goal is not achieved, if the PTO considers the claims to be overly broad, the patent owner may be forced to amend them. Those amendments may further distinguish the claims from what the third party is doing or plans to do, possibly enhancing non-infringement defenses. Likewise, any arguments made by the patent owner during the reexamination proceeding may help the third party to have the claims interpreted more narrowly or may create estoppels that would prevent the patent owner from relying on the doctrine of equivalents to ensnare equivalent products or processes.

Additionally, claim amendments may trigger “intervening rights,” which essentially preclude the patent owner from seeking infringement damages for activities occurring before the completion of reexamination.39 The statute provides for both “absolute” and “equitable” intervening rights. If “substantive” claim amendments are made during reexamination, absolute intervening rights preclude recovery for all products made, purchased, used, or imported before the issuance of the

34 See, e.g., Am. Hoist & Derrick Co. v. Sowa & Sons, Inc., 725 F.2d 1350, 1364 (Fed. Cir. 1984) (“[B]ecause the PTO has now held the claims in suit patentable in light of the additional art . . . , [defendant’s] burden of proof of unpatentability has become more difficult to sustain.”).

35 See, e.g., Custom Accessories, Inc. v. Jeffrey-Allan Indus. Inc., 807 F.2d 955, 961 (Fed. Cir. 1986); Thermal Eng’g Corp. v. Clean Air Sys., Inc., 706 F. Supp. 436, 443 (W.D.N.C. 1987).

36 E.I. du Pont de Nemours & Co. v. Cetus Corp., 19 U.S.P.Q. 2d 1174, 1180 (N.D. Cal. 1990). 37 See id.38 Am. Hoist, 725 F.2d at 1360 (discussing the effect of a reissue proceeding).39 35 U.S.C. §§ 252, 307 (2000); see generally Westvaco Corp. v. Int’l Paper Co., 991 F.2d 735 (Fed. Cir. 1993); Laitram Corp. v. NEC

Corp., 952 F.2d 1357 (Fed. Cir. 1991); Fortel Corp. v. Phone-Mate, Inc., 825 F.2d 1577 (Fed. Cir. 1987); Kaufman Co. v. Lantech, Inc., 807 F.2d 970 (Fed. Cir. 1986).

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reexamination certificate.40 Depending on the factual circumstances, the third party challenger may also persuade a court to grant “equitable” intervening rights, under which the challenger and its customers may continue manufacturing, selling, offering for sale, importing, and using allegedly infringing products at least to recoup its investment prior to the issuance of the reexam certificate.41

Reexamination can also be used to help establish the “materi ality” prong of the inequitable conduct defense, by which a court can hold a patent unenforceable if it is shown that certain persons intentionally withheld “material” prior art information from the PTO during the original prosecution. That is because “the result of a PTO proceeding that assesses patentability in light of information not originally disclosed can be of strong probative value in determining whether the undisclosed information was material.”42 On the other hand, failure of a party alleging inequitable conduct to include a reference in a reexamination request “weighs heavily against” any argument that the reference was material.43

IV. Reexamination Tactics

A. Reexamination Goals and Tactics by Third Party Challengers

Reexamination allows a patent challenger to pursue several goals, including:

(1) seeking to have claims in the patent canceled or at least narrowed to increase the chal-lenger’s non-infringement defenses or to provide grounds for intervening rights;

(2) forcing the patent owner to submit arguments in favor of patentability that might cre-ate narrower claim interpretations or estoppels to enhance the challenger’s non-in-fringement defenses;

(3) showing that certain prior art withheld during the original prosecution is material; or(4) seeking a less expensive forum for adjudicating validity questions and seeking to stay

concurrent, more expensive district court proceedings during that adjudication.

Other reasons for seeking reexamination include the benefits of going to an expert forum such as the PTO over seeking to invalidate a patent in front of a jury or a court, which may be confused by the complexity of the technology or have its judgment about validity issues impacted by other issues to be decided in an infringement case.44 Challengers may also seek reexamination because of the procedural benefits discussed above.

40 Cf. BIC Leisure Prods., Inc. v. Windsurfing Int’l, Inc., 774 F. Supp. 832, 837 (S.D.N.Y. 1991) (granting absolute intervening rights based upon the defendant having an order for the infringing goods in hand on the reissue of the patent), aff’d in pertinent part, 1 F.3d 1214 (Fed. Cir. 1993).

41 35 U.S.C. § 252 (2000). Few courts have granted such rights. Compare Wayne-Gossard Corp. v. Sondra, Inc., 434 F. Supp. 1340, 1363 (E.D. Pa. 1977) (noting that defendant’s sales before the critical date amply compensated it for its investment and denying equitable intervening rights), aff’d, 579 F.2d 41 (3d Cir. 1978), with Plastic Container Corp. v. Cont’l Plastics, Inc., 607 F.2d 885, 903 (10th Cir. 1979) (allowing infringers “to recoup [their] investment and to offset, against any infringement damages, the reasonable cost of converting or replacing [their] present equipment in order to produce noninfringing goods.”) and Richardson-Vicks, Inc. v. Upjohn Co., Civ. A. No. 93-556, 1996 WL 31209 (D. Del. 1996) (granting intervening rights following a reexamination and applying a 7% running royalty to defendant’s sales to compensate patent owner).

42 Molins, PLC v. Textron, Inc., 48 F.3d 1172, 1179 (Fed. Cir. 1995); see also Glaverbel Societe Anonyme v. Northlake Mktg. & Supply, Inc., 45 F.3d 1550 (Fed. Cir. 1995).

43 Sensonics, Inc. v. Aerosonic Corp., 81 F.3d 1566, 1571 (Fed. Cir. 1996).44 See generally William J. Speranza & Michael L. Goldman, Reexamination-The Patent Challenger’s View, 15 A.I.P.L.A. Q.J. 85 (1987).

KILPATRICK STOCKTON

When a third party has been accused of infringement, additional factors can be identified that, if present, favor use of a reexamination, especially inter partes reexamination. For instance, reexamination should at least be considered where: an accused infringer has limited litigation resources; the case is mostly about past damages and the prior art presents a chance of claim amendments resulting in intervening rights; the technology is complex and likely to be viewed by the jury or court as presumptively entitled to a patent; and substantial existing non-infringement or invalidity defenses will remain whatever the reexamination outcome.

Despite the presence of such factors, the tendency of reexamination proceedings to result in confirmed, if amended, patent claims suggests a cautious approach in selecting the reexamination option. Thus, when the main defense is invalidity and only weak to fair non-infringement defenses exist, reexamination may not be appropriate given the apparent bias favoring confirming some claims. This is especially true given that a court or jury may be all too willing to defer to the PTO’s judgment on the effect on patent validity of the prior art already considered. However, if inter partes reexamination is available (i.e., the patent issued on or after November 29, 1999), the third party may have a better chance at obtaining claim cancellation because of the greater amount of participation permitted.

A third party may employ various tactics to increase the chances that claims are amended or canceled in reexamination. For instance, PTO statistics indicate that the chances of having claims canceled or changed increase if a third party files a reexamination request.45 Thus, when the patent is in litigation and the patent owner requests reexamination of its own patent, the accused infringer should consider filing a second request seeking to put its views in front of the PTO. Indeed, some third parties in ex parte settings, to enhance their ability to participate, have filed multiple requests, typically refuting the patent owner’s responses to examiner’s actions that issue in the ex parte phase of reexamination.46 If inter partes reexamination is available, the third party challenger will have a much greater procedural advantage in the reexamination process.

In addition to tactics implemented to enhance chances of a “successful” reexamination outcome, third parties accused of infringement should give thought to the tactical advantages reexamination offers in the context of the overall dispute. First, the substantially reduced cost of reexamination is a powerful incentive for less funded defendants to use the procedure because it tends to level the playing field. This incentive is enhanced when the reexamination may allow for a stay of expensive concurrent district court litigation.

Likewise, during the long delay occasioned by reexamination, changes in priorities in the strengths of the case and, likely, in the market environment may possibly favor the accused infringer. For example, if during that time the product becomes less important, the patent owner may become

45 Id. The same data show that having an examiner other than the one who originally issued the patent assigned to the reexamination also enhances the chances that claims will be canceled or amended. Oral reports circulate among the bar of successful motions to recuse particular examiners from handling reexaminations of patents they originally issued, but no reported decisions reflect such recusals. But see In re Ovshinsky, 24 U.S.P.Q.2d 1241 (Comm’n of Pat. & Trademarks 1992) (finding no bias by the examiner against the patent owner and denying patent owner’s petition to recuse examiner assigned to reexamination proceeding).

46 PTO rules provide for consolidating such multiple requests, provided they are timely. 37 C.F.R. § 1.565 (2008); mpep, supra note 3, § 2283. Other rules, however, provide some protection for the patent owner by stating that, “in aggravated situations where it appears clear that the second or subsequent request was filed for purposes of harassment, the request should be denied.” mpep, supra note 3, § 2240.

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reluctant to expend resources enforcing the patent even if it survives reexamination. Or, if the accused product is removed from or phased out of the market during reexamination and the patent owner is also forced to narrow its patent claims, the resulting possible intervening rights may significantly decrease the case value. That is particularly so if concurrent district court proceedings are stayed. A stay may convince the patent owner to settle, because it will be unable to get a judgment for the one-to-two-year period it takes to complete the reexamination proceeding. A stay also provides the requester the opportunity to find and evaluate additional, possibly invalidating prior art while preventing the patent owner from taking expensive discovery of the requester.

The very threat of a reexamination proceeding also may be a powerful tactic that could force a belligerent plaintiff to the negotiation table. Few patent owners, particularly ones engaged in an extensive licensing or enforcement program, can face the prospect of their patent being tied up for 18 months or more in a reexamination proceeding without seriously considering a reasonable settlement proposal. One such proposal could hinge on the reexamination outcome. For instance, the accused infringer could propose settling the case by paying “X” if the patent does not survive reexamination; a greater amount “Y” if the patent survives, but the claims are narrowed; or an even larger amount “Z” if the patent survives unscathed. “X,” “Y,” or “Z” could be fixed amounts or changing royalty payments for past and future sales.

B. Reexamination Tactics by Patent Owners

Obviously, patent owners seek to survive reexamination with an intact or substantially intact patent and then argue that the court or jury should defer to the PTO’s expert view on validity issues. Patent owners may also seek new, narrower claims that cover infringing products yet, because they are narrower, are more likely to survive challenges to their validity following reexamination. To avoid possible intervening rights, patent owners may seek such narrower claims by rewriting original, still allowable dependent claims into independent form.47

Once a certificate confirming original, new, or amended claims issues, the patent owner can then rely on the heightened presumption of validity generally accorded to the reexamined patent. Likewise, if a request for reexamination is denied, that very denial will also give the patent owner powerful arguments that the prior art cited neither impacts the validity of its patent nor is sufficiently material to support any inequitable conduct allegations if it was art that was arguably withheld during earlier prosecution.

Tactically, an enhanced, stronger patent allows the patent owner to more readily obtain a preliminary injunction, since the patent’s presumed validity strongly supports a likelihood that the patent owner will successfully thwart an invalidity defense.48 If litigation has been stayed or will soon commence,

47 See 35 U.S.C. § 305 (2000) (prohibiting patent owners from seeking broader claims). 48 See e.g., Am. Permahedge, Inc. v. Barcana, Inc., 857 F. Supp. 308 (S.D.N.Y. 1994); Auto. Prods. PLC v. Fed.-Mogul Corp., 11 U.S.P.Q.

2d 1471 (E.D. Mich. 1989).

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a patent owner also can use the fact that the patent was successfully reexamined or that a request for reexamination was denied to more readily defend a summary judgment of invalidity.49

Even better, patent owners may in some limited circumstances seek summary judgment that the patent is “not invalid” in view of the defendant’s prior art, thereby narrowing the issues for the court or jury to infringement. For example, the court in Transmatic, Inc. v. Gulton Industries50 granted partial summary judgment of validity and in doing so observed that “[t]he Court will especially give deference to the PTO’s patentability decision in this case because the PTO found the . . . invention pa tentable twice--initially and upon reexamination.”

Of course, the third party challenger’s procedural benefits are the patent owner’s burdens. For example, the presumption of validity whose benefit is lost to the patent owner during reexamination is a powerful shield that sometimes may be all that prevents a fact finder from determining the invention was taught by the prior art. Thus, patent owners with a weak patent facing potentially strong art may wish to avoid reex amination and instead rely on the statutory presumption.

V. Conclusion

A reexamination proceeding is a powerful dispute resolution tool that both patent owners or patent challengers may wield to great effect. It provides a relatively efficient forum in which to confirm validity of patents on valid inventions and eliminate patents on technology that does not constitute true invention deserving of patent protection.

49 For example, in reissue proceedings, the Federal Circuit has consistently required district courts to consider the fact that the PTO considered the prior art during reissue. See, e.g., Fromson v. Advance Offset Plate, Inc., 755 F.2d 1549 (Fed. Cir. 1985); Am. Hoist and Derrick Co. v. Sowa & Sons, 725 F.2d 1350 (Fed. Cir. 1984).

50 818 F. Supp. 1052, 1063 (E.D. Mich. 1993), aff’d in part, rev’d in part, 53 F.3d 1270, 1275 (Fed. Cir. 1995).

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

OTHER TOPICS

Sweepstakes and Game Promotions Basics

J. David Mayberry, Daniel H. Marti, Tywanda Harris Lord, and Amanda L. McCoy

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Sweepstakes and Game Promotions BasicsJ. David Mayberry, Daniel H. Marti, Tywanda Harris Lord, and Amanda L. McCoy

For the savvy brand owner, sweepstakes and consumer-based prize contests are popular promotional techniques used to generate consumer interest, revenue, and brand awareness. This article provides an overview of the major legal issues to consider when structuring, advertising, and conducting such a promotion, and highlights best practices for complying with applicable state and federal regulations.

I. What is a Game of Chance?

Various terms are used to describe prize contests where an element of chance is involved, including “sweepstakes,” “game promotions,” “gift enterprises,” “prize promotions,” and “games of chance.” For purposes of this article, the terms will be used interchangeably and refer generally to contests that are conducted in connection with the sale of consumer products or services in which prizes are awarded on the basis of a chance event over which the participants exercise no control.1

II. Structuring a Game of Chance in View of State Lottery Laws

When structuring a game promotion, it is critical to keep in mind that the contest must not violate state laws prohibiting illegal lotteries. A “lottery” is generally defined as a game in which the elements of prize, chance, and consideration are present.

(1) Prize: Anything of value awarded to the winner(s). E.g., a sum of money; a free trip; a television.

(2) Chance: The outcome of the game depends upon factors not in the participant’s control. E.g., a random drawing; scratch-off instant win.

(3) Consideration: Monetary: the payment of money for the opportunity to participate. E.g., purchase of a product; payment of an entry fee; cashing-in of loyalty program points.

Non-monetary: the expenditure of a substantial degree of effort for the opportunity to participate. E.g., multiple visits to a store; completion of a lengthy questionnaire.

Because the right to conduct a lottery is typically reserved to the state itself, a non-state entity conducting a sweepstakes contest must ensure that one of the three elements listed above is eliminated. Where the sponsor has elected to retain the elements of prize and chance, as in the case of a sweepstakes, the element of consideration must be removed in order to render the promotion

1 See, e.g., Fla. Stat. ann. § 849.094(1)(a) (West Supp. 2009) (“‘Game promotion’ means, but is not limited to, a contest, game of chance, or gift enterprise, conducted within or throughout the state and other states in connection with the sale of consumer products or services, and in which the elements of chance and prize are present.”).

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lawful.2 Thus, for example, a company might be conducting an illegal lottery where: (1) contest participants are required to purchase the sponsor’s product to enter, (2) a winner is selected in a random drawing from among all eligible entries received, and (3) the winner receives two round trip airline tickets.

A person or entity found to be conducting an illegal lottery may be guilty of a misdemeanor or a felony, and/or subject to a fine. In North Carolina, for example, an offender will be guilty of a Class 2 misdemeanor, which may include a fine of up to $2,000.3 In Florida, conducting an illegal lottery is a felony of the third degree.4

The most common way to eliminate consideration and avoid an illegal lottery is to offer a free alternative method of entry (commonly known as an “AMOE”). In the above example, if contest participants are given the option to enter the sweepstakes by either purchasing the sponsor’s product or mailing the entrant’s name and contact details to the sponsor without requiring a purchase, then the risk that the promotion would be considered an illegal lottery is significantly decreased. Allowing participants to enter a contest by calling a toll-free telephone number is another possible AMOE. Note that minimal costs associated with an AMOE do not necessarily create an illegal lottery. For example, when the AMOE is a mail-in entry method, the cost of the paper and stamp to send the entry is generally not deemed to be consideration.

When implementing a game promotion, all entries received through a free AMOE must be treated with “equal dignity” as those entries submitted through purchase. For example, an operator may not create a separate prize pool for the free entries, and the sponsor should avoid separate entry deadlines for free entries and purchase entries. Similarly, each free entry should have the same value as each purchase entry.

Often what is more difficult than eliminating consideration is recognizing consideration in the first place. As new modes of technology are developed, this question has become even more murky. For example, where a contest is only conducted via the Internet, it is now generally accepted that the cost of subscribing to an Internet Service Provider is not deemed consideration because: (1) subscription to Internet service has become increasingly commonplace; (2) an entrant is not likely to subscribe to an Internet service solely for the purpose of entering a contest; and (3) free access to the Internet is readily accessible in public libraries and other community centers.5

By contrast, the practice is not as well settled with respect to text messaging promotions since the technology is newer and there have been fewer test cases. Where a participant can only enter a promotion by sending a text message entry to the sponsor, there is still some question as to whether standard text messaging charges constitute consideration. Note, however, that premium billed

2 See, e.g., Id. § 849.094(2)(e) (“It is unlawful for any operator . . . [t]o require an entry fee, payment, or proof of purchase as a condition of entering a game promotion.”).

3 See n.C. Gen. Stat. § 14-290 (2007).4 See Fla. Stat. ann. § 849.09(2) (West Supp. 2009).5 Notably, however, an in-store promotion with an AMOE that is only available on the Internet may not provide “equal dignity” unless

the AMOE is given equal prominence to the purchase method of entry in the advertising and promotional material. See Press Release, Office of the Attorney General for the State of New York, CVS Pays Fine for Sweepstakes Violation (Oct. 16, 2006) (on file with author), available at http://www.oag.state.ny.us/media_center/2006/oct/oct16a_06.html.

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charges would likely be deemed consideration. As new means of e-commerce continue to develop, an AMOE should be offered if there is any question that the method of entry might require payment on the part of the consumer.

Finally, because consideration can be non-monetary, it is also critical to assess the level of time and effort that an entrant will incur to enter the contest. For example, where a consumer must complete a burdensome or lengthy questionnaire in order to enter a sweepstakes, the sponsor may not have effectively eliminated the element of consideration. A short and simple survey, on the other hand, is less likely to raise a red flag. As a general rule, the greater the degree of effort required to enter, the greater the risk that consideration may be found to exist. Although challenges to contests requiring non-monetary consideration have been rare, it is possible that requiring contestants to make significant efforts to enter could be deemed consideration.6 Therefore, best practices dictate that any significant efforts for entry—such as completing a lengthy survey or making multiple store visits—should be curtailed unless an AMOE is offered.

III. Structuring a Game of Chance in View of State and Federal Gambling Laws

Although sweepstakes are less frequently challenged under state and federal gambling laws as they are under lottery laws, a promotion operator should be wary of structuring a promotion that might be considered a “game for game’s sake,” and therefore illegal gambling.

In a traditional game of chance, the opportunity to win a prize is generally incidental or secondary to the purchase of a product or service offered by the sponsor. Thus, the participant receives something of value. Gambling, by contrast, is less about the promotion of the product or service, and more about the game itself. Therefore, where the product or service promoted is wholly incidental to the game, it is possible that even an AMOE will not be sufficient to save the contest from running afoul of gambling laws.7 If the participants are paying primarily for a chance to win as opposed to the underlying product or service, then the sponsor should seek counsel as to whether the promotion might constitute illegal gambling.

IV. Preparing the Official Rules for a Game of Chance

Every promotion should be governed by official rules that set forth the material terms of the promotion, including certain disclosures described in the categories below. Many of these provisions are required by state laws and all are recommended as a best practice. Rules should be posted conspicuously wherever participants may enter the game (e.g., on the Internet, in retail outlets) and must not be modified once published. The rules should be clear and unambiguous, not repetitive, and not overly dense.

A. Eligibility

Explain who is eligible to participate in the promotion. Consider age, geographic restrictions, and other special restrictions (such as licensed drivers or employees in a particular trade). Take care to

6 See, e.g., Seattle Times Co. v. Tielsch, 495 P.2d 1366 (Wash. 1972) (finding consideration where participants were required to spend hours in following a football forecasting contest and the benefit flowed to the promoter).

7 See, e.g., F.A.C.E. Trading, Inc. v. Dep’t of Consumer & Indus. Affairs, 717 N.W.2d 377 (Mich. Ct. App. 2006).

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list any excluded parties (e.g., employees of the sponsor and the sponsor’s advertising and promotion agencies, and immediate family members of each such employee). The promotion should be “void where prohibited.”

B. How to Enter

Specify the beginning and end dates of the promotion and provide clear instructions for each available method of entry (including an AMOE). The disclosure “no purchase necessary” must be made clearly and conspicuously.

C. Prizes and Selection of Winners

Specify the odds of winning (this may be a fixed number or may depend on the number of entries received); the date on which potential winner(s) will be selected; how the winner(s) will be selected; the number of prizes to be awarded; a description of each prize to be awarded; the approximate retail value of each prize; and how the prizes will be awarded. If the prize consists of a vacation or trip, include details pertaining to the number of days/nights, dates, destination, transportation, accommodations, meals, spending money, etc. Disclose that federal, state, and other tax liabilities arising from the contest are the sole responsibility of the winner.

D. Suggested Releases and Limitations on Liability

“Sponsor is not responsible for lost, late, stolen, incomplete, illegible, inaccurate, undelivered, delayed, or misdirected entries.”

“Sponsor reserves the right, in its sole discretion, to modify or terminate this Sweepstakes in the event of any act, occurrence, or reason that it believes would corrupt the integrity, administration, or fairness of the Sweepstakes.”

“By participating in the Sweepstakes, participants agree to release, discharge, and hold harmless Sponsor, its respective parents, affiliates, subsidiaries, advertising and promotion agencies, and other individuals engaged in the development or execution of this Sweepstakes, from any liability, claims, losses, and damages arising out of or relating to their participation in this Sweepstakes or the acceptance, use, misuse, or possession of any prize received in this Sweepstakes.”

E. Winners List

Specify how to request a list of winners without charge. Include a deadline for receiving requests in order to avoid having to fulfill such requests indefinitely.

F. Sponsor Information

Include the complete name and address of the sponsor of the contest.

The promotion must be implemented in accordance with the written rules. Consequently, a sponsor is advised not to wait until the last minute to finalize the specific elements and structure of the game. Particularly in states where registration is required in advance (see below), these details should be settled ahead of time.

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Obviously, a game promotion may be considered illegal under various state laws if winners are predetermined, the game is manipulated for winners in a certain geographic region, entries are arbitrarily removed or rejected, or the sponsor circulates deceptive game promotion literature. These schemes should clearly be avoided.

V. State Registration and Bonding Requirements for a Game of Chance

The states of Florida and New York require registration of games of chance, and either a trust account or a surety bond, for any game promotion in which the total value of all prizes offered is over $5,000. Rhode Island also requires registration, but only when the promotion is offered in retail outlets.

Florida has taken the position that where a game of chance is not open to the public, it does not need to be registered. Unfortunately, however, there is not a standard definition for what constitutes the “public.” For example, it is possible that a game that is open only to the employees of the sponsor’s organization may not be considered open to the public, and therefore exempt from registration requirements, whereas a game that is open to the employees of a third party organization may be subject to registration requirements. This is a fine line to be sure, and it is possible that the various states requiring registration will decide differently which contests should be registered. New York could take the position that a contest need not be registered, while Florida might accept registration of the very same contest. When in doubt, it is preferable from a legal standpoint to err on the side of registering the contest, and allowing the state to decide whether such registration is unnecessary.

Consequences for failure to register a game promotion include criminal and civil penalties. In Florida, an entity that fails to register is guilty of a misdemeanor of the second degree and a civil penalty of up to $1,000.8 Failure to register in New York is a Class B misdemeanor.9

Details regarding registration in Florida, New York, and Rhode Island follow below.

A. Florida10

Florida requires that the operator of a game promotion file an application for registration with the Department of Agriculture and Consumer Services and either establish a trust account or obtain a surety bond if:

(1) The promotion is conducted in connection with the sale of consumer products or ser-vices;

(2) The elements of chance and prize are present; and(3) The total value of the prizes offered is greater than $5,000.

Details regarding Florida registration and bonding are as follows:

8 Fla. Stat. ann. § 849.094(9)(a)–(b) (West Supp. 2009).9 n.Y. Gen. BuS. § 369-e(1) (McKinney 1996).10 Fla. Stat. ann. § 849.094(4) (West Supp. 2009).

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(1) The application for registration is available online at: http://www.doacs.state.fl.us/on-estop/forms/10951.pdf.

(2) A copy of the Official Rules and a $100 filing fee must accompany the application.(3) A trust account must be established, or a surety bond must be obtained, in an amount

equivalent to the total value of all prizes offered.(4) The application and bond must be filed with the State at least 7 days before the com-

mencement of the promotion.(5) A certified list of winners (for all prizes valued over $25) must be filed with the State

within 60 days after the winners have been finally determined.

B. New York11

The State of New York requires that the operator of a game promotion file an application for registration with the Secretary of State and either establish a trust account or obtain a surety bond if:

(1) The promotion is conducted in connection with the promotion, advertising, or sale of consumer products or services;

(2) The elements of chance and prize are present; and(3) The total value of the prizes offered is greater than $5,000.

Details regarding New York registration and bonding are as follows:

(1) The application for registration is available online at: http://www.dos.state.ny.us/corp/pdfs/mrgoc.pdf.

(2) A copy of the Official Rules and a $100 filing fee must accompany the application.(3) A trust account must be established, or a surety bond must be obtained, in an amount

equivalent to the total value of all prizes offered.(4) The application and bond must be filed with the State at least 30 days before the com-

mencement of the promotion.(5) A list of winners (for all prizes valued over $25) must be filed with the State within 90

days after the completion of the promotion.

C. Rhode Island12

Rhode Island requires that an operator of a game promotion file an application for registration with the Secretary of State if:

(1) The promotion is one in which a retail establishment offers the opportunity to receive prizes, as determined by chance; and

(2) The total value of the prizes offered is greater than $500.

11 n.Y. Gen. BuS. law § 369-e (McKinney 1996).12 R.I. Gen. lawS § 11-50-1 (2002).

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Details regarding Rhode Island registration are as follows:

(1) The application for registration is available online at: http://www.sec.state.ri.us/corps/GC/gc.html.

(2) A copy of the Official Rules and a $150 filing fee must accompany the application.(3) There is no trust account or surety bond requirement.(4) The Rhode Island statute does not provide a stated timeframe in which the application

must be filed. As a best practice, the application should be filed as soon as it is com-pleted, and in all cases, prior to the commencement of the contest.

(5) Although Rhode Island does not require that the sponsor file a list of winners with the State, the sponsor must maintain a list of winners for a period of six months following the completion of the contest in the event that the Secretary of State desires to review the same.

VI. Advertising a Game of Chance

Any advertising or promotion of a game of chance should be consistent with the official rules, and certain states require posting of the rules at retail establishments. At a minimum, some states provide that advertisements should clearly and conspicuously disclose the “material terms” of the contest, including:

(1) “No purchase necessary” and free method of entry;(2) Disclosure of where the game is void;(3) Eligibility requirements, including age and geographic location;(4) Beginning and end dates of promotion, and times if applicable;(5) Odds of winning;(6) Name of sponsor of the promotion; and(7) Promotion subject to complete Official Rules, and where complete rules can be ob-

tained.

Consider also the context of the advertisement: the more heavily a purchase is encouraged in the advertising, the more prominent the “no purchase necessary” disclosure should be. In 2005, the Attorney General of New York challenged a sweepstakes promotion conducted by Johnson & Johnson with respect to its Tylenol® brand. Advertising for the promotion contained large bold print reading “BUY TYLENOL.” Even though an AMOE was offered, information about the AMOE appeared only in the fine print at the bottom of the advertisement. The settlement required disclosure of the AMOE with “equal prominence” to the payment method of entry.13

In addition, any materials sent through the U.S. Postal Service that include entry forms for a sweepstakes must comply with the federal Deceptive Mail Prevention and Enforcement Act.14 Such materials must disclose not only that “no purchase is necessary to enter,” but also that “a purchase

13 Press Release, Office of the Attorney General for the State of New York, Tylenol Manufacturer to Amend Sweepstakes Ads (Sept. 10, 2004) (on file with author), available at .http://www.oag.state.ny.us/media_center/2004/sep/sep10a_04.html.

14 39 U.S.C.A. §§ 3001–3017 (West, WESTLAW current through P.L. 111-12).

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will not improve an individual’s chances of winning.”15 The materials must also include all terms and conditions of the sweepstakes or contest, including entry procedures, the sponsor, estimated odds of winning, the quantity, estimated retail value, and nature of each prize, and the schedule of any payments made over time.16 Moreover, sponsors must adopt reasonable practices to prevent the mailing of such matter to any person who requests removal from the sponsor’s sweepstakes mailing list, and the sponsor must maintain records of all such requests for a period of five years.

Another point to consider with respect to advertising: If a sponsor wishes to use a third party trademark in connection with its promotion, the safest course of action is to obtain clearance from the trademark owner for use of its intellectual property. For example, if the sponsor of a promotion is offering a Acme Company Widget® as the grand prize, the sponsor may wish to seek Acme’s approval before using the Widget® name and mark on its promotional materials. While nominative fair use of a trademark may not be problematic, sponsors should always keep federal and state unfair competition laws in mind. If offering a third party product as a prize, the sponsor should be careful not to cause confusion or mistake, or to deceive with respect to the affiliation, connection, or association of the sponsor with the third party, or the sponsorship or approval of the promotion by the third party.17

VII. What is a Game of Skill?

A game of skill, in contrast to a game of chance, is a promotion in which prizes are awarded to winners based on their skill or ability to perform certain required tasks. Because the element of chance is eliminated, a skill contest is not considered an illegal lottery and (with the possible exception of Arizona) does not trigger state registration requirements.

Skill contest sponsors must be particularly careful not to introduce chance into the contest, thereby subjecting the contest to state lottery laws. For these reasons, objective judging criteria should be established and clearly communicated to participants prior to their entry in the contest, and the rules should clearly disclose the specific and objective criteria on which entries will be judged, and the weight given to each criteria. Also include a description of the judges’ qualifications and methods of judging.

Most states employ the “dominant element test” to determine whether chance has been introduced into a promotion. Under this test, all factors of the contest are considered; if chance predominates in determining the winner, then the game will be deemed a game of chance rather than a game of skill.

(1) Examples of Skill Contests:

(a) Trivia questions (b) Photography contests

15 See id. § 3001(k)(3)(A)(ii)(I)–(II) (Matter is not acceptable in the mail if it “does not contain a statement that discloses in the mailing, in the rules, and on the order or entry form, that no purchase is necessary to enter such sweepstakes; [and] (II) does not contain a statement that discloses in the mailing, in the rules, and on the order or entry form, that a purchase will not improve an individual’s chances of winning with such entry.”)

16 Id. § 3001(k)(3).17 See 15 U.S.C. § 1125 (2006).

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(c) Essay-writing contests

(2) Examples of Non-Skill Contests:

(a) Predicting the outcome of a sports event (b) Guessing the number of beans in a jar

Even tie-breakers should be based on pre-established skill criteria, not chance. By way of example, where a company sponsors an essay contest in which two participants receive the same high score, and the first place winner is determined by a random drawing between the two, the sponsor may not have effectively eliminated the element of chance. To avoid this scenario, the sponsor might consider providing for an additional “run-off” skill contest, or awarding duplicate prizes to the highest scorers.

Even assuming that chance has been properly eliminated in a skill contest, some states also restrict entry fees, purchase requirements, or other payment in skill contests. The following representative state regulations provide examples of the general restrictions and guidelines surrounding consideration in skill contests:

(1) No additional payment or fees should be required to advance to next level or to be eligible for prize (e.g., Arizona18, California19).

(2) Requirement that contestant purchase a product (as compared to an entry fee) to par-ticipate is prohibited in various states (e.g., Maryland20).

(3) The winning prize cannot constitute a fund from which the “purse prize” is to be paid; that is, entry fees should not be pooled to serve as the “jackpot” (e.g., Florida21).

(4) Some states prohibit the requirement of any kind of entry fee, service charge, purchase or similar consideration in order to enter or to continue to remain eligible in any kind of game of skill, contest, sweepstakes, giveaway, or other promotion (e.g., Vermont22).

Notably, Arizona requires that the operator of an “intellectual contest or event” in which a purchase is required register with the State Attorney General’s Office.23 Details regarding Arizona registration are:

(1) The application is available online at: http://www.azag.gov/consumer/gambling/RegForm.pdf.

(2) A copy of the Official Rules (including rules applicable in the case of a tie) must ac-company the application.

(3) The application must include a sworn statement that no increment has been added to the established purchase price for the product.

18 aRIz. Rev. Stat. ann. § 13-3301 to 3312 (West 2001 & Supp. 2008).19 Cal. BuS. & PRoF. § 17539.1(a)(14) (West 2008).20 Md. Code, CoM. law § 13-305(b) (West 2002).21 Fla. Stat. ann. § 849.094 (West Supp. 2009).22 vt. Stat. ann. tIt. 13, § 2143b (1998).23 aRIz. Rev. Stat. § 13-3301, 13-3311.

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(4) There is no filing fee.(5) There is no surety bond requirement.(6) The application must be filed with the State before the commencement of the promo-

tion.(7) A list of winners (for all prizes) must be filed within 10 days following the award of

all prizes.24

VIII. A Note on Charitable Raffles

A raffle, by definition, includes the elements of prize, chance, and consideration. While contests inclusive of all three of these elements are generally prohibited by state lottery laws, an exception may be made for qualified non-profit organizations that secure the necessary raffle permit from the applicable governmental office. It is recommended that all raffles be conducted in accordance with a complete set of official rules, both for purposes of disclosure with respect to the structure of the raffle, and in order to limit the sponsor’s liability with respect to the potential use or misuse of the raffle prize.

What if a commercial enterprise wants to co-venture with a not-for-profit company to conduct a raffle? For example, suppose that Acme Company offers to donate to Philanthropy Organization an Acme Widget to be raffled to the public, with revenue derived from the raffle ticket sales to benefit Philanthropy Organization. This can be a mutually beneficial venture as it may increase product sales and provide positive publicity for Acme Company, while at the same time creating a source of revenue for Philanthropy Organization.

Some states regulate such “charitable sales promotions” by requiring that the parties enter into and file with the state a contract setting forth details such as: a description of the goods/services offered, the geographic area and time frame in which the promotion will occur, a provision for a final accounting to the charitable organization, and/or the contributions of each entity to the operation of the promotion and the collection and management of the proceeds.25 Some state laws also require that the amount or percent of sales that will be used to benefit the charitable organization be disclosed in advertising relating to the raffle.

As with games of chance, the law of the state in which the raffle is being conducted should be carefully reviewed well in advance of conducting such a promotion.

IX. Conclusion

This article is meant to provide some practical pointers about sweepstakes and promotion law that will be useful in considering how to structure and conduct a successful and compliant promotion.

While planning and operating games of chance can trigger a variety of state and federal regulations, all of which should be carefully reviewed prior to commencing such a promotion, there are certain key themes that are repeated throughout the regulations. These themes include clear and conspicuous

24 Id. § 13-3311.25 See, e.g., Conn. Gen. Stat. ann. § 21a-190a (West 2006).

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disclosure of material terms; consistency between official rules, advertising, and implementation of the promotion; registration in certain states; and general operation and implementation of the contest in good faith.

KILPATRICK STOCKTON

INTELLECTUAL PROPERTYDESK REFERENCEPATENTS, TRADEMARKS, COPYRIGHTS AND RELATED TOPICS

WWW.KILPATRICKSTOCKTON.COM

OTHER TOPICS

Taxation of Intellectual Property

Lynn E. Fowler, Don Reiser, and Jerry N. Smith

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Taxation of Intellectual PropertyLynn E. Fowler, Don Reiser, and Jerry N. Smith

I. Introduction

The tax rules surrounding intellectual property (“IP”) are indeed a tangled web that even experienced tax practitioners have trouble navigating. This circumstance is in part because the concepts are antiquated and have not kept up with innovations in technology and intellectual property law.

This paper provides an overview of some of the principal concepts in the taxation of IP. Section II, III and IV summarize some of the basic principles of acquiring and disposing of IP. Sections V and VI discuss some of the basic tax planning involved in multi-jurisdictional business operations, both multi-state businesses and multi-national businesses.

II. Characterizing Transfers of IP

One of the critical issues in taxing IP is characterizing the transaction between the IP owner and the user. In general, if the IP owner relinquishes legal title and all substantial rights to the IP for a fixed payment, tax law characterizes the transaction as a sale of the underlying IP. Most transfers of the use of IP, however, do not fall neatly into the bucket described above. For example, the IP owner might retain title and transfer some or all of the economic rights. The characterization of the IP often is contingent on the productivity of the IP to the user. These transactions can lead to fine distinctions in characterizing the transaction for Federal income tax purposes.

The tax law does not rely on the transfer of legal title to characterize the transaction between a sale and a license. Nor does it rely on the characterization of the transaction under applicable IP law. For example, the tax law characterizes many “licenses” of IP as sales for tax purposes.

If the tax law classifies the transaction as a sale or exchange, the transferor offsets the amount realized against its adjusted basis (its tax “cost” in the asset), and the difference can be capital gain or loss if the property is a capital asset or qualifies for special treatment under Internal Revenue Code (“IRC”) § 1231. On the other hand, if the tax law classifies the transaction as a license or lease, the transferor must report the amounts received as ordinary income, subject to depreciation or amortization of the adjusted basis of the property if the property qualifies for such deductions.

For many years, the characterization of IP transfers was solely the purview of the common law and the subject of numerous judicial battles between taxpayers and the Internal Revenue Service (“IRS”). More recently, Congress has enacted provisions stipulating the tax characterization of many transactions. As discussed below, however, the legislation is not comprehensive, and case law continues to prescribe the rules to characterize many transactions.

A. Case Law

The principal litigated issues regarding IP transaction characterization revolve around three features of IP transactions, although the facts of many cases address multiple issues.

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1. Contingent Payments

Initially, the IRS took the position that payments contingent on the transferee’s sales or profits were like royalties, because they were spread out over a period of years and gave the transferor an continuing interest in the property, and thus should not be given capital gains treatment. Had the courts agreed with this theory, virtually no transfers of IP would have qualified as a sale of the IP for tax purposes, because the difficulty of valuing IP usually dictates the parties to employ a royalty arrangement. Largely for this reason, the courts regularly rejected the IRS position and the IRS has long since conceded this issue.

2. Geographical and Field-of-Use Restrictions

Owners of patents, copyrights, and other intangibles often limit licensees’ exploitation of the IP to specified geographical areas or fields of use. The IRS’s original position was that the IP was indivisible, so that geographical and functional divisions were indicative of a license even if the user obtained exclusive rights within the specified domain. The IRS’s indivisibility theory of IP was also rejected by the courts, which held that the transfer of exclusive rights to a patent, copyright, or trademark could be a sale for tax purposes even if restricted to a geographical area or a prescribed field of use. The IRS surrendered on this issue in 1954.

3. Reservations of Control

An owner of IP typically retains some control over geographical and field-of-use restrictions by requiring the assignee to adhere to quality and other standards prescribed by the assignor. Drawing the line between “the reservation of sufficient rights and restrictions merely to protect [the taxpayer’s] continuing financial interest and the reservation of rights to continuing participation in the business on such a scale that it cannot properly be said that there was a sale” has proven problematic for courts. Moreover, because the court analyzes both the conduct of the parties and their formal contract rights in determining whether the arrangement is a sale license, the outcome of these particular cases is of limited predictive value.

4. Summary of Case Law

In sum, the case law looks to whether the taxpayer disposes of all substantial rights in the underlying IP to distinguish between sales or exchanges of the IP and licenses of the IP. The more control that the owner places on the user’s use of the IP, the greater the likelihood of a characterization of the IP as a license.

B. IRC § 1235

IRC § 1235 characterizes a transfer by a “holder” of a patent of all substantial rights to that patent as a sale or exchange of a capital asset held for more than one year. This characterization applies even if the amounts received are payable periodically during the transferee’s use of the patent or are contingent on the productivity, use, or disposition of the transferred property. Since its enactment in 1954, § 1235 has proven useful to provide inventors and other eligible holders a capital gain safe harbor without having to rely on the sometimes confusing case law discussed above.

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1. Holder Defined

For purposes of § 1235, a holder must be an individual. Primarily, the holder is the individual whose efforts created the invention. The term also includes an individual who (1) acquired an interest in the invention for money or money’s worth, paid to the creator before the invention’s reduction to practice, and (2) is neither the creator’s employer nor a related person when the rights acquired are determined and the amount to be paid is fixed.

2. Transfer of All Substantial Rights

To qualify for preferential treatment under § 1235, the holder must transfer “all substantial rights to a patent, or an undivided interest therein which includes a part of all such rights.” The language of the instrument of transfer is not controlling, so that a transfer of the requisite rights can satisfy § 1235 whether it is called a sale, license, or assignment.

The regulations provide that “all substantial rights to a patent” means all rights (whether or not then held by the transferor) that are of value at the time of the transfer. Accordingly, the holder may retain a security interest to ensure performance or payment without destroying sale or exchange treatment. Moreover, the regulations require an analysis of all the circumstances to determine whether retention of a right to prohibit sublicenses or sub-assignments or a failure to convey the right to use or sell the patent is substantial.

An assignment of an exclusive right to exploit a patent in a single field of use or geographical area does not satisfy the “all substantial rights” requirement of § 1235. In other respects, however, the principles determining whether all substantial rights have been transferred follow those used to ascertain the existence of a sale or exchange, as opposed to a license, in situations not subject to § 1235.

For example, while a transferor’s retention of a right to terminate for nonperformance is not inconsistent with a completed transfer, a right to terminate at will before the patent’s expiration renders § 1235 inapplicable and negates sale or exchange status. On the other hand, the failure to make an express grant of the right to use a patented product is consistent with a transfer of all substantial rights if the right is either insubstantial or granted by implication.

3. Transfers Outside of § 1235

While § 1235 guarantees capital gain treatment to any holder meeting its conditions, other taxpayers can qualify for capital gain treatment under the case law discussed above without adverse inference from their exclusion from § 1235.

C. IRC § 1253

Section 1253 characterizes “transfers” of trademarks, trade names, and franchises. For this purpose, a transfer includes a renewal of the rights. Any “transfer” of a trademark, trade name, or franchise is not a sale or exchange if the transferor retains “any significant power, right, or continuing interest” with respect to the subject matter of the franchise, trademark, or trade name. Moreover, amounts paid on account of the transfer of a trademark, trade name, or copyright that are contingent on the

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productivity, use, or disposition of the IP are taxable as ordinary income. A transfer that runs afoul of § 1253 cannot be recharacterized as a sale or exchange under the common law principles discussed above.

Section 1253 specifies the significant powers, rights, and significant interests that would cause the transfer not to be a sale or exchange, as follows:

(1) A right to disapprove any assignment of such interest, or any part thereof;(2) A right to terminate at will;(3) A right to set standards for products sold, services furnished, or promotional equip-

ment and facilities; (4) A right to require that transferee sell or advertise only transferor’s products; (5) A right to require that transferee buy substantially all supplies and equipment from

transferor; or(6) A right to payments contingent on productivity, use, or disposition.

Unlike § 1235, § 1253 also provides specific rules characterizing payments by the user of the IP. Amounts paid on account of the transfer of a trademark, trade name, or copyright that are contingent on the productivity, use, or disposition of the IP are deductible by the payor, if such payments are (1) one of a series of payments payable at least annually and (2) such payments are relatively equal in amount or payable in accordance with a fixed formula. This treatment is similar to the treatment of royalties. All other payments are capitalized in the tax basis of the IP, similar to purchase price.

III. Recovering the Cost of Acquiring IP

Generally, the cost of purchasing IP is not currently deductible but is instead “capitalized” in the cost of the IP and recovered through ratable amortization over a period of years. The method and term of amortization depends on the circumstances under which the taxpayer acquired the IP.

A. IRC § 197

If § 197 applies to an asset, the taxpayer amortizes the cost of the asset equally over the 180-month period beginning with the month of acquisition. Section 197 applies to the following acquisitions of IP.

1. Patents and Copyrights

Section 197 applies to patents and copyrights, with two important exceptions. First, § 197 does not apply to the costs of developing a patent or copyright by the taxpayer. Second, § 197 does not apply to the purchase of a patent or copyright in a transaction (or series of transactions) pursuant to which the taxpayer does not acquire the assets of a trade or business. As a result, § 197 applies only to patents or copyrights acquired by a taxpayer in connection with the purchase of a trade or business.

2. Franchises, Trademarks, and Trade Names

Section 197 applies to acquisitions of franchises, trademarks, and trade names, irrespective of whether the taxpayer acquires the asset in connection with the purchase of a trade or business.

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Accordingly, the cost of acquiring a franchise are amortizable over a 15-year period regardless of the length of the franchise right. Moreover, the cost of renewing a franchise is treated as a separate asset subject to a separate 15-year amortization period beginning with the month of renewal. The new 15-year period does not apply to any unamortized cost of acquiring the original franchise (or prior renewals).

B. IRC § 167

If § 197 does not apply to the costs of acquiring IP, § 167 determines the method of amortizing the cost. These rules would apply to the cost of developing patents and copyrights as well as the cost of purchased patents or copyrights not acquired in connection with the purchase of a trade or business.

1. Cost of Self-Developed Patents and Copyrights

A taxpayer may amortize the cost of a patent or copyright using one of two approved methods. First, the taxpayer may depreciate the cost ratably over the legal life of the patent, under the so-called straight-line method. If a patent or copyright becomes valueless in any year before its expiration the taxpayer may deduct the unrecovered cost or other basis in that year.

Alternatively, the taxpayer may recover costs of the patent or copyright under the “income forecast method.” Pursuant to that method, the depreciation deduction for any year is computed by multiplying the property’s original basis by a fraction, the numerator of which is the income from the property earned in that year and the denominator is the anticipated total income from the property.

The income estimate used in applying the method can only include income for the period consisting of the year that the property is placed in service and the succeeding ten years. The taxpayer must adjust the estimated revenues periodically to reflect changes in circumstances.

2. Separately Purchased Patents and Copyrights

A special rule applies to purchased patents or copyrights with purchase price payable on at least an annual basis as either a fixed amount per use or a fixed percentage of the revenue derived from the use of the patent or copyright. In that case, the amortization expense is equal to the amount of that purchase price paid or incurred during the year. Otherwise, the taxpayer amortizes the patent or copyright over the remaining useful life of the IP using one of the methods described above.

C. IRC § 174

Tax law permits a current deduction of certain “research and experimental expenditures.” The taxpayer may elect to defer the expenditures and amortize them for a period of not less than 60 months. The taxpayer may adopt the current deduction method without the IRS’s consent only for the first tax year that it incurs qualifying expenditures. Once adopted, the current expense method must be used for all qualifying expenditures in that year and in later years, unless the taxpayer gets the IRS’s consent to capitalize and amortize the expenditures.

For this purpose, “research and experimental expenditures” are research and development costs in the experimental or laboratory sense. Whether expenditures qualify as research or experimental expenditures depends on the nature of the activity to which the expenditures relate, not the nature of

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the product being developed or the level of technological advancement the product or improvement represents. A product for this purpose includes any pilot model, process, formula, invention, technique, patent, or similar property, including products to be used by the taxpayer in its trade or business and products to be held for sale, lease, or license. It also includes the cost of obtaining a patent, such as attorneys’ fees incurred in making or perfecting a patent application.

IV. Disposing of Intellectual Property

Under tax principles, a disposition of IP characterized as a sale or exchange under the principles described in Section II above can be a taxable transaction pursuant to which the taxpayer recognizes gain or loss equal to the excess of the sales price over the adjusted tax basis of the IP. In certain circumstances, however, the transaction will qualify for “nonrecognition” treatment, meaning the taxpayer defers the gain or loss until it later disposes of the property received in exchange for the IP.

A. Status of IP as Capital Asset

One of the major stakes in disposing of IP is whether any gain or loss from the disposition is subject to the special rules for capital assets. Under current law, an individual’s gains with respect to capital assets held for more than one year are treated as long-term capital gains and taxed at a maximum rate of 15%. Capital assets held for not more than one year are treated as short-term capital gains and are taxed at the individual’s ordinary income tax rate. An individual may only deduct $3,000 of capital losses in excess of capital gains in any tax year. Capital gains recognized by corporations are taxed at the same rate as ordinary income, and corporations may deduct capital losses only against capital gains.

1. Assets Held by Creator

One major issue is whether the creator of IP can treat the IP as a capital asset. The answer depends on the type of IP.

A holder of a patent treats the taxable disposition of a patent as the sale of a capital asset held for greater than one year, irrespective of the actual period that the holder actually held the patent. A holder includes the individual whose efforts created the patent. Accordingly, an individual inventor may treat gain from the disposition of a patent as long-term capital gain.

A copyright held by the person whose efforts created the work is not a capital asset.

Transfers of franchises, trademarks, and trade names are not treated as sales of capital assets if the transferor retains any significant rights, as discussed above. Moreover, payments contingent on the productivity, income, or use of the IP are taxable as gain that is not long-term capital gain.

2. Assets Used in a Trade or Business

If a taxpayer develops or acquires IP that it uses in its trade or business and which is depreciable, special rules under § 1231 apply to the gain. In that case, any gain from the sale of such IP held for greater than one year is treated as long-term capital gain. A copyright cannot qualify for the special treatment under § 1231, however.

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B. Taxation of Contingent Payments

Payments based on the productivity, use, or income of the IP are generally reported under the “installment method.” Under the installment method, the taxpayer recognizes for any taxable year from a disposition as it receives payments in the proportion that the payments received in that year bears to the total contract price.

With respect to contingent payment sales, special rules allocate the taxpayer’s basis to payments received and to be received in the sale. The rules distinguish between contingent payment sales depending upon sale price and payment term:

(1) If the contingent payments have a maximum selling price, the basis is recovered in the same proportion as the payments in the year bears to the maximum selling price.

(2) If the contingent payments do not have a maximum selling price, but the time over which the payments will be made is determinable, the taxpayer will recover its basis ratably over such period.

(3) If the contingent payments have neither a maximum sales price or a fixed period over which payments are to be made, the taxpayer recovers its basis ratably over a period of 15 years commencing with the date of sale.

A taxpayer may elect not to have the installment method apply to deferred payment sales, in which case the taxpayer would be taxable in the year of disposition based on the fair market value of the stream of contingent payments (plus the amount of any fixed payments). This valuation exercise of the contingent payments can be extremely complex, due to the uncertainty around the payments themselves.

C. Tax Deferred Dispositions

The IRC permits a taxpayer who exchanges property for certain other property not to recognize gain or loss at the time of the exchange, effectively deferring the taxable event until a subsequent realization event. For example, pursuant to § 351, a taxpayer does not recognize gain or loss on an exchange of IP for stock of a corporation that the transferor (together with other transferors of property) controls immediately after the transfer. Similarly, pursuant to § 721, a taxpayer does not recognize gain or loss on the exchange of IP for an interest in a partnership (or limited liability company taxable as a partnership).

A key issue in determining the applicability of these sections in an exchange is whether the taxpayer’s transfer of IP to the entity constitutes property for tax purposes. Under the case law discussed in Section I.A. above, the tax law will recognize a transaction as a transfer of property if the taxpayer transfers all substantial rights to the IP, including transfers subject to geographic or field of use limitations.

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V. Use of IP in Multi-State Enterprises (the IP Holding Company)

A. Background

Many states, primarily in the eastern United States, permit or require affiliate entities to file separate tax returns for each entity in the affiliated group, even when the entities file a single consolidated federal income tax return. This filing system leads to a tax planning structure to shift income attributable to IP from operating companies operating in separate return states to a state that does not tax the income attributable to IP.

Delaware, for example, exempts the income of a corporation domiciled in Delaware if its sole activity in Delaware is the maintenance and management of intangible investments. Other states, such as Nevada, have no corporate income tax.

The tax planning strategy involves setting up an affiliated entity (“IP Holdco”) in a state like Delaware or Nevada. The sole purpose of IP Holdco is to acquire the IP used within the business and license the use of the IP to the operating companies throughout the affiliated group.

The anticipated tax benefit from this strategy is that the operating companies could deduct the payment of royalties to IP Holdco, reducing the taxable income in states where the corporations file separate returns. IP Holdco reports the income in its state of domicile, but under the rules of that state, the royalty income is not subject to tax.

For the IP Holdco strategy to be successful, IP Holdco must have activities in Delaware sufficient to establish nexus there, and must avoid any activity outside Delaware that might establish nexus with another state. In addition, IP Holdco must not be a member of a unitary business that has to file a consolidated or combined return with other members of the affiliated group.1

B. Nexus

Nexus refers to the Constitutional requirements for the minimum contacts necessary to establish a state’s right to impose an income tax obligation on an out-of-state corporation. The nexus concept derives from the Commerce Clause. According to the Supreme Court in Complete Auto Transit, Inc. v. Brady,2 the Commerce Clause precludes a state from taxing a corporation unless “substantial nexus” exists. Moreover, according to the Court in Quill Corp. v. North Dakota,3 substantial nexus requires a physical presence in the state attempting to tax the corporation.

Accordingly, businesses that implemented IP Holdco strategies took great care to create a physical presence in the domicile of IP Holdco, and to limit the activities of IP Holdco in other states. For example, officers of IP Holdco would travel to its domicile to sign checks and agreements, even if they had other duties within the organization.

1 Several states, such as California, Michigan, and Illinois, require all entities engaged in a unitary business to file a single return for the entire group. This rule eliminates the benefits for taxes paid to those states.

2 430 U.S. 274 (1977).3 504 U.S. 298 (1992).

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C. Georgia Attack on IP Holdcos

Georgia imposes its corporate income tax on the portion of a corporation’s net income that it derives from and is reasonably attributable to property owned and business done in Georgia. Georgia does not have any laws specifically addressing IP Holdco.

In an early test of the IP Holdco strategy, the Georgia Department of Revenue (the “GDOR”) unsuccessfully attempted, in Aaron Rents, Inc. v. Collins,4 to reallocate the income of an IP Holdco to a Georgia based corporation by arguing that the IP Holdco was a sham corporation. In Aaron Rents, the Georgia corporation assigned a trademark to the IP Holdco (domiciled in Delaware), and the IP Holdco licensed the trademark back to the Georgia corporation.

The GDOR argued that the IP Holdco was a sham created for the sole purpose of tax avoidance, and that the financial transactions between the Georgia corporation and the IP Holdco were arbitrary shifts of income that should be disregarded in determining the taxable income of the Georgia corporation, effectively denying the deduction for the royalties paid to IP Holdco. The superior court held that there were adequate and valid non-tax reasons for establishing the IP Holdco:

(1) To protect and enhance the value of the trademarks;(2) To segregate the trademarks from other company assets to enable quantification of

profit from the trademarks;(3) To protect the intangibles against claims of creditors; and(4) To give the in-state corporation greater flexibility to pursue other business strategies.

The court also found the following factors persuasive in determining that the IP Holdco had engaged in sufficient business activity to be a separate and distinct corporate entity:

(1) It maintained a separate corporate office in Delaware;(2) It maintained separate bank accounts;(3) It incurred operating costs;(4) It contracted in its own name;(5) It collected income and incurred expenses;(6) It filed its own Delaware franchise tax returns; and(7) It had its own corporate officers and board of directors who held regular meetings.

D. Attacks on the IP Holdco Strategy

The Aaron Rents case stands as a rare taxpayer victory in a war by separate states on the IP Holdco strategy. States have focused on one of three main lines of attack to eliminate the tax savings of the IP Holdco strategy.

1. Addbacks

One line of attack on the IP Holdco strategy is for a state to legislatively deny the royalty deduction to the operating company by “adding back” that deduction. States that have employed addback

4 No. D-96025, (Fulton County Super. Ct. June 27, 1994), cert denied No. 94D-1773 (Ga. Aug. 24, 1994).

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legislation include Alabama, Connecticut, Indiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, North Carolina, Ohio, New York, Rhode Island and Virginia.

2. Forced Combined Reporting

Other states have used existing statutes or have enacted statutes to require IP Holdco to file a combined return with the operating company in that state. The combined return effectively eliminates the deduction by the operating company by including the corresponding income of the IP Holdco in the combined return. Prior to implementing its addback statute, New York attempted, with mixed results, forcing a combination of IP Holdcos with their corresponding operating companies. In addition, Virginia has implemented this attack in the past.

3. Taxing the IP Holdco

The final line of attack is for the state in which the operating company operates to attempt to tax the IP Holdco. The major hurdle in this attack is for the state to assert that the IP Holdco has sufficient nexus in that state.

In most of the reported cases, the state does not assert that the IP Holdco has a physical presence in the state. However, in Geoffrey, Inc. v. South Carolina Tax Commission,5 the South Carolina Supreme Court held that the state had sufficient nexus to tax an IP Holdco even without a physical presence in the state.

In Geoffrey, Toys “R” Us established an IP Holdco—Geoffrey, Inc. (“Geoffrey”)—for the purpose of holding and managing the Toys “R” Us trademarks. Geoffrey then licensed to each operating affiliate the right to use the trademarks, and each affiliate agreed to pay a royalty to Geoffrey based on a specified percentage of net sales.

South Carolina assessed Geoffrey for the tax that the operating company would have paid on this income on the theory that Geoffrey had “economic nexus” with the state. The South Carolina Supreme Court subsequently determined that Geoffrey had to file income tax returns and pay income tax in South Carolina even without any physical presence in the state. The court found it sufficient to establish nexus that Geoffrey owned intangible property used by an in-state affiliate—in this instance, the Toys “R” Us affiliate in South Carolina.

The Geoffrey decision has been much discussed in tax circles, but the Supreme Court denied certiorari in this case and has refused similar appeals from other states. Emboldened by the silence of the Supreme Court on the nexus issue, other states, including Arkansas, Florida, Missouri, New Mexico, and Ohio, have adopted rules subjecting the IP Holdco to tax in their states.

E. The Future of IP Holdcos

The aggressive attacks on the tax benefits by states has certainly chilled the implementation of IP Holdcos as a tax planning strategy. In our experience, companies would not consider establishing an IP Holdco in the current environment. Moreover, many companies have either already implemented

5 437 S.E. 2d 13 (S.C. 1992), cert denied 510 US 992.

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or are considering implementing alternative structures due to the diminished state tax benefits of the IP Holdco structure.

VI. Use of IP in Multi-National Enterprises

Because IP is typically a major contributor to the profitability of most multinational companies, U.S. tax planning involving the offshore ownership and exploitation of IP has become more common. Moreover, as multinational companies continue their global expansion and also strive to improve business efficiencies through operational restructurings (often involving the centralization of certain business functions), the opportunities for reducing tax costs through effective IP tax planning have increased.

At its core, IP tax planning for a U.S.-based multinational involves determining which affiliate (or affiliates) within its worldwide group should derive income from the exploitation of that IP outside the U.S. Once this determination is made, the multinational company must address a number of complex U.S. (as well as foreign) tax rules and considerations in order to achieve the desired tax savings resulting from the IP tax planning. In addition, any IP tax planning within an affiliated group must satisfy the arm’s length requirements of the U.S. and applicable foreign transfer pricing regulations and guidelines. Some of these tax and transfer pricing considerations are highlighted below.

A. Methods and Tax Consequences of Transferring Intellectual Property Offshore

In general, a U.S. multinational can transfer IP (or economic rights with respect to that IP) to a foreign affiliate for exploitation outside the U.S. through one of the following four methods.

1. Sale

A U.S. multinational corporation can sell the IP to a foreign affiliate either for a fixed lump sum price or for payments that are contingent upon the use of that IP by the affiliate (i.e., effectively, royalty payments). Under U.S. transfer pricing rules prescribed by § 482, more fully discussed in Section D below, the purchase price paid by the foreign affiliate must represent an arm’s length consideration for the IP purchased in the transaction. On a sale of the IP, the U.S. seller of the IP would recognize gain to the extent the arm’s length consideration received exceeds its tax basis (generally cost) in the IP. In addition, if the foreign affiliate pays the purchase price in installments rather than in a lump sum amount, interest would generally be required (or imputed) to the seller for U.S. tax purposes.

Because a sale of IP is a taxable event, the immediate U.S. tax cost associated with a sale to a foreign affiliate will generally be substantial and will often be prohibitive. This alternative method for transferring IP offshore, however, may be worth considering in circumstances where the upfront tax cost can be minimized either through the use of existing tax losses to offset all or part of the gain on the transfer, or where there is little or no gain inherent in the IP either due to its high tax basis or low value (which may apply, for example, to a transfer of early stage, unproven technology). As noted below, determining the “right” value of IP for U.S. tax purposes is a difficult and challenging exercise and the ability of the IRS and other taxing authorities to make retroactive purchase price

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adjustments in the case of transfers to offshore affiliates often creates uncertainty with respect to valuation issues.

2. License

Instead of selling the IP, a U.S. multinational can license the IP to a foreign affiliate in exchange for arm’s length royalty payments based on the use of that IP outside the U.S. The royalty payments received will be taxable to the U.S. multinational and will be treated as foreign source income to the extent the IP is used outside the U.S. Furthermore, under certain “look-through” rules, the foreign source royalties received by the U.S. multinational will be characterized as “general category income,” for foreign tax credit purposes, to the extent allocable to “general category income” of the foreign affiliate. Thus, if the foreign affiliate actively exploits the IP in its business, the royalties received should generally be treated as general category foreign source income (which is typically more beneficial).

Depending on the jurisdiction of the foreign affiliate, the royalties paid to the U.S. multinational may be subject to local country withholding taxes, which may be reduced or eliminated under an applicable income tax treaty with the U.S. Some countries also require recording royalty-bearing licenses with IP, fiscal, or other authorities and/or governmental approval of as a prerequisite to payment of royalties outside of the country.

3. Contribution

A U.S. multinational can also contribute the IP to a foreign affiliate in exchange for shares of common stock in that affiliate. Although a transfer of property to an 80% owned affiliate for stock is generally treated as a tax-free transaction, an exception exists with respect to the contribution of IP to a foreign corporation. Specifically, if a U.S. company transfers IP to a foreign affiliated corporation in a transaction that otherwise qualifies as a tax-free contribution or corporate reorganization, the U.S. transferor is treated as having sold the IP in return for annual payments contingent upon the productivity, use or disposition of such IP (i.e., royalties). Thus, even though no actual payments would be made by the foreign affiliate, the U.S. company is taxed annually on a deemed royalty over the life of the IP contributed.6 The deemed royalties received by the U.S. company are sourced and characterized, for foreign tax credit purposes, in the same manner as actual royalties (and hence will generally be foreign source “general category income” if the IP is used offshore in an active business).

4. Cost Sharing

Although not involving a legal transfer of existing IP, a U.S. multinational can enter into a qualified cost sharing arrangement (“CSA”) with a foreign affiliate under which the parties contractually agree to share the costs and risks of developing new IP resulting from such arrangement in proportion to their shares of “reasonably anticipated benefits” from their individual exploitation of that IP. Under a CSA, the foreign affiliate is treated as a having an economic (but not legal) ownership interest in

6 Because the U.S. company does not actually license the IP to the foreign affiliate (and does not actually receive any royalty payments), the offshore jurisdiction will not allow a royalty expense deduction to the offshore affiliate for any such deemed payments (potentially resulting in double taxation).

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the newly developed IP under such arrangement and the exclusive right to profits attributable to its respective interest in the cost shared IP. A U.S. company can therefore own and license existing IP to a foreign affiliate and also transfer “economic” ownership with respect to future IP to that affiliate under a CSA. However, under a CSA, the foreign affiliate must compensate the U.S. company for any existing IP (and certain other resources and capabilities) developed, maintained, or acquired by such U.S. company and which is reasonably anticipated to contribute to the development of the new IP. Determining the amount of compensation that must be paid by the foreign affiliate to the U.S. company for its “platform contribution” to a CSA is perhaps the most significant issue that must be addressed under this alternative.

B. Offshore Exploitation of Intellectual Property

A foreign affiliate that owns or licenses IP can exploit that IP by licensing the rights to either other foreign affiliates or unrelated third parties in exchange for royalty payments. Alternatively, the foreign affiliate can use the IP in connection with the manufacture of products for sale to related or unrelated parties, in which case the affiliate’s economic return on that IP is effectively embedded in the purchase price of the products sold. Although the foreign affiliate may be subject to a low rate of income tax on the royalty or sales income in its local country, such income could also be subject to U.S. taxation under the anti-deferral provisions contained in Subpart F of the IRC. If these provisions apply, the royalty or sales income earned by the foreign affiliate will be subject to current U.S. tax law even if the income is not actually repatriated to its U.S. shareholders through dividend distributions. As a result, a significant component of U.S. tax planning and structuring with respect to the offshore exploitation of IP involves navigating around these complex anti-deferral rules.

Under the Subpart F rules, if a foreign affiliate controlled by a U.S. company (i.e., a controlled foreign corporation or “CFC”), licenses the IP to a related affiliate, the royalties received by that foreign licensor are currently taxed to the U.S. company regardless of whether the royalties are remitted back to the U.S. By contrast, if the CFC licenses the IP to an unrelated party, the royalties are not currently taxed to the U.S. company if they are derived in the active conduct of a trade or business. A CFC can only satisfy this relatively narrow “active royalty” exception if (1) it has developed, created or produced the IP (or acquired the IP and added substantial value to such IP) and is regularly engaged in the development, creation or production of IP of such kind, or (2) it is regularly engaged in marketing the IP outside the U.S. through its own employees located in the foreign country and through an organization that is substantial in relation to the amount of royalties derived from the licensing of the IP.

If the foreign affiliate/CFC does not license the IP, but instead employs the IP in manufacturing and selling products, current U.S. taxation of the sales income under Subpart F can be avoided if the affiliate either physically manufactures the products or makes a “substantial contribution” through the activities of its own employees to the physical manufacture of the property by another party under a contract manufacturing or tolling arrangement. Thus, subject to the potential application of certain “branch rules,” sales income earned by a foreign affiliate/CFC that actually manufactures or substantially contributes to the manufacturing of products using the IP is not currently taxed in the U.S., even if the CFC sells the products to other affiliated entities in the corporate group.

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C. Transfer Pricing Considerations

In order to prevent the inappropriate shifting of profits between controlled entities, the U.S. transfer pricing rules contained in § 482 and regulations require that a sale, license, contribution, or cost sharing arrangement with respect to IP between controlled parties must satisfy the arm’s length standard. This standard requires that the results of the IP transfer between the U.S. company and its foreign controlled affiliate must be consistent with the results that would have been realized if uncontrolled parties had engaged in a comparable transaction under comparable circumstances. A transaction involving uncontrolled parties need not be identical in order to be considered “comparable” to a transaction between controlled parties, but must be sufficiently similar such that it provides a reliable measure of an arm’s length result. In addition, the consideration for the transfer of IP must also be “commensurate with the income” produced by the use of the IP over time. Under this latter requirement, the IRS may periodically adjust the consideration for the transfer of the IP (e.g., by adjusting the sales price or the royalty rate to allocate more income to the U.S. company) to ensure that such consideration continues to be commensurate with the income currently produced by that IP.

The U.S. transfer pricing regulations provide that the arm’s length consideration with respect to the transfer of IP to a controlled entity under either a sale, license, or contribution transaction must be determined under one of the following four methods: (1) the comparable uncontrolled price method, (2) the comparable profits method, (3) the profit split method, or (4) any unspecified method. The regulations require, however, that this determination must be made by using the method that produces the most reliable measure of an arm’s length result for the controlled transaction, taking into account all the facts and circumstances. The primary factors in determining the “best” transfer pricing method are the degree of comparability between the controlled and uncontrolled transactions, the quality of the data, and the reliability of the assumptions used in the analysis. To the extent that the consideration for the transfer of IP between controlled entities falls within an “arm’s length range” of results derived from IP transfers between uncontrolled entities, the transfer would generally satisfy the arm’s length standard. Some foreign taxing authorities also apply transfer pricing rules that may result in a valuation that differs from that acceptable to the IRS.

With respect to a CSA, recently issued regulations set forth various methods for determining the arm’s length consideration required to compensate the cost sharing participants for any existing IP and other resources (referred to as “platform contributions”) made available under such arrangement and which is reasonably anticipated to contribute to developing new “cost-shared” IP. In situations where a foreign affiliate shares in the cost of future IP development, but does not contribute any existing IP to the CSA, these regulations significantly limit the economic returns that can be realized by the foreign affiliate from its economic ownership interest in the new IP.

VII. Conclusion

Historically, tax planning with respect to domestic and foreign transfers and licensing of IP has been a fruitful area to reduce taxation. However, as the U.S. federal and state and foreign governments have aggressively attempted to eliminate or reduce the opportunities for abuse and focus more upon

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the true substance of these transactions in determining whether or not taxation is appropriate, the opportunities afforded by careful tax planning have been correspondingly reduced. However, active tax planning in this arena is still necessary, not only to assess whether there remain areas for tax reduction, but to make sure that planned activities do not inadvertently result in unexpected taxation.

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