2nd Circuit Affirms Trademark Infringement and Dilution Suit Based on the Removal of Unique Production Codes from Gray-Market Goods

In Zino Davidoff SA v. CVS Corp., 91 USPQ2d 1038 (2d Cir. 2009), Davidoff owned uncontested trademarks for all of its COOL WATER products, which are high-end luxury colognes.  The products are manufactured and marketed by Coty, Inc. (“Coty”) and its subsidiaries, under license from Davidoff. 

Davidoff and Coty developed comprehensive quality assurance and anti-counterfeit measures that involved the placement of a unique production code (UPC) on the bottom of each COOL WATER product.  Embedded within the code is information about that particular unit, including time and place of production, the production line, ingredients used, the distributor and intended customer.

The code is an effective tool in fighting counterfeits and ensuring product quality.  By checking the code to determine if it is fake or duplicate, Davidoff is able to identify counterfeit products.  Further, Davidoff regularly instructs its retailers and officers of the U.S. Customs and Border Protection (“Customs”) in the use of its UPC system and fake UPC numbers known to be in use by counterfeiters.  The code assists Davidoff in protecting its brand against quality issues in genuine authorized products.  When quality problems arise, the UPC can be utilized to determine which products are affected, enabling a recall of distributed products that are defective. 

Davidoff limited the sales of its products to luxury retailers, and declined to sell its products to CVS.  CVS secured stock of COOL WATER products from outside of Davidoff’s normal distribution channels and counted the products among their top-selling fragrances.  Some of the COOL WATER products sold by CVS were found to be counterfeit, while others were gray-market goods (meaning they were manufactured under Davidoff’s authorization, legally purchased outside theU.S.for distribution, and then illegally imported for sale without Davidoff’s permission).

In 1998 and 2005, Davidoff discovered counterfeit COOL WATER products were being sold at CVS.  Each time, Davidoff sent cease-and-desist letters to CVS and informed them how to identify counterfeit products based on the UPC.   Davidoff again discovered in 2006 that CVS was selling counterfeit COOL WATER products.  Davidoff then brought this suit against CVS for trademark infringement, unfair competition and trademark dilution in violation of Sections 32(1) and 43(a) and (c) of the Lanham Act, 15 U.S.C. §§ 1114(1), 1125(a) and 1125(c). Davidoff’s original complaint sought relief only as to CVS’s marketing of counterfeit Davidoff products.

On December 22, 2006, the district court granted a temporary restraining order and authorized Davidoff to inspect all undistributed products in CVS’s inventory that bore the Davidoff COOL WATER mark. Davidoff discovered that the UPCs on the packages and labels affixed to the bottle had been removed from 16,600 items in CVS’s inventory. The codes had been removed by cutting the portion of the box or label exhibiting the UPC, using chemicals to wipe away the UPC on the label, and grinding away the bottom of the bottles to remove the UPC.  In many instances, the packaging had been opened.

On February 7, 2007, Davidoff amended its complaint to allege claims based upon CVS’s sale of Davidoff products with the UPC removed. On March 2, 2007, CVS voluntarily agreed to halt the sale of counterfeit Davidoff products, but not the products with the codes removed. In response, Davidoff moved for a preliminary injunction forbidding the sale of all its trademarked goods with code removed. The court granted Davidoff’s motion. Zino Davidoff SA  v. CVS Corp., No. 06-cv-15332, 2007 WL 1933932 (S.D.N.Y. July 2, 2007). The district court reasoned that removal of the codes from Davidoff’s trademarked product impaired Davidoff’s marks by interfering with the trademark owner’s ability to identify counterfeit goods and to control the quality of its legitimate products by identifying and recalling defective products. The district court held that Davidoff was likely to succeed on the merits of its trademark infringement claims on the theory that CVS’s sale of Davidoff’s trademarked products with the codes removed constituted trademark infringement. CVS appealed the district court’s judgment.

The Second Circuit reviewed the issue of the preliminary injunction for abuse of discretion on the part of the district court.  The Court held that in cases involving trademark infringement and dilution, a party seeking a preliminary injunction must demonstrate (1) the likelihood of irreparable injury in the absence of such an injunction, and (2) either (a) likelihood of success on the merits or (b) sufficiently serious questions going to the merits to make them a fair ground for litigation plus a balance of hardships tipping decidedly toward the party requesting the preliminary relief. (citing Fed. Express Corp. v. Fed. Espresso, Inc., 201 F.3d 168, 173 (2d Cir. 2000)). Under this standard, the Second Circuit affirmed the district court’s grant of a preliminary injunction.

Davidoff likely to succeed on the merits of its trademark infringement claims

CVS appealed the district court’s judgment on the grounds that the goods with the codes removed were gray-market goods, or genuine Davidoff goods sold by Davidoff through authorized channels in other countries. CVS asserted that because the goods were sold in their original packaging with the Davidoff trademarks visible and unaltered, the removal of the UPC codes did not negate their genuineness or constitute infringement.  The Second Circuit dismissed this argument, stating that the fact that the products in question are gray-market goods is not a defense to infringement.  Rather, the issue is whether, or under what circumstances, the sale of gray market goods infringes a trademark.  The Second Circuit noted with approval that the district court based its grant of a preliminary injunction on the basis that the removal of Davidoff’s codes unlawfully interfered with Davidoff’s trademark rights, regardless of whether the goods were authorized by Davidoff for sale.

CVS also argued that the Lanham act did not support the conclusion that a retailer may be found liable for trademark infringement for selling a genuine product in its original packaging with the registered trademark intact because the production code has been altered or removed.  For support, CVS pointed to failed attempts to amend the Lanham Act to include a prohibition on the alteration or removal of production codes.  The Second Circuit rejected this argument as well, relying on a Supreme Court case cautioning that “failed legislative proposals are a particularly dangerous ground on which to rest an interpretation of a prior statute.” Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511U.S. 164, 187 (1994).  The case held that congressional inaction lacks persuasive significance because the inaction does not point to a specific conclusion, with equally tenable inferences drawn from the inaction, including the inference that the legislation already incorporated the requested language. 

The Second Circuit further agreed with the District Court that Davidoff was likely to succeed on the merits that CVS’s sales of its products with the UPC removed constituted trademark infringement. The Second Circuit recognized that, generally, the Lanham Act does not impose liability for “the sale of genuine goods bearing a true mark even though the sale is not authorized by the mark owner” because such a sale does not inherently cause confusion or dilution. Polymer Tech. Corp. v. Mimran, 975 F.2d 58, 61 (2d Cir. 1992). However, the Court agreed that goods must conform to the trademark holder’s quality control standards to be genuine, Polymer Tech. Corp. v. Mimran, 37 F.3d 74, 78 (2d Cir. 1994), or should not materially differ from the product authorized by the trademark holder for sale, Original Appalachian Artworks, Inc. v. Granada Elecs., Inc., 816 F.2d 68, 73 (2d Cir. 1987). The Second Circuit held that where the alleged infringer has interfered with the trademark holder’s ability to control quality, the trademark holder need not necessarily show that the goods sold were defective because interference with legitimate steps to effect quality control would unreasonably subject the holder to risk of injury to the reputation of the mark. The Court noted that “[O]ne of the most valuable and important protections afforded by the Lanham Act is the right to control the quality of the goods manufactured and sold under the holder’s trademark.” El Greco Leather Prods. Co. v. Shoe World, Inc., 806 F.2d 392, 395 (2d Cir. 1986).

The Second Circuit asserted that consumers are assured that goods conform to the mark holder’s quality standards by association of the trademark with the holder’s goods, and are often willing to pay more to buy goods bearing a mark with a reputation for high quality.  Davidoff asserts that its codes effect quality control by permitting the easy detection of counterfeits and improving Davidoff’s ability to identify, target and remedy production defects.  The Second Circuit again pointed to its precedent in Warner-Lambert Co. v. Northside Dev. Corp., 86 F.3d 3 (2d Cir. 1996), holding that a trademark holder is entitled to an injunction based on the subversion of its quality control measures by showing that “(i) the asserted quality control procedures are established, legitimate, substantial, and nonpretextual, (ii) it abides by these procedures, and (iii) sales of products that fail to conform to these procedures will diminish the value of the mark.” The Second Circuit found that the requirements for the injunction were met.

Detection of Counterfeits

The Second Circuit found that counterfeiters often either omit the UPC or use sets of identical fake codes when dealing with products that have unique production codes.  The Court found Davidoff’s evidence to show that its UPC system enables Davidoff to identify counterfeit products by scanning for goods that lack a UPC or exhibit a UPC known to be used by counterfeiters.  The Second Circuit relied on the district court’s fact-finding that Davidoff regularly trained retailers, private investigators and U.S. Customs to utilize UPCs to identify and seize counterfeit products.  Thus, the Second Circuit agreed with the district court’s holding that the first two prongs of the Warner-Lambert formulation were met because Davidoff’s quality control procedures were “legitimate, substantial, and nonpretextual” and Davidoff “abides by these procedures.”   The Second Circuit also agreed with the district court’s conclusion that the third prong of the Warner-Lambert analysis was also met because the loss of the quality control protections would expose Davidoff to a higher incidence of sales of counterfeit goods and harm Davidoff’s reputation and diminish the value of its trademark.

Identification of Defective Products and Effective Recall

The Second Circuit noted that the district court also based its finding on Davidoff’s use of its code system to protect against quality defects in genuine products. Referencing the code when a quality defect is discovered in a product helps identify the source of the problem and facilitates correction.  Further, upon discovery of a quality issue, the code system permits easy, rapid identification of affected products that are already in the chain of distribution, to facilitate a targeted recall that will remove the defective goods from the channels of commerce while leaving unaffected goods in place.

In response, CVS argued that the code system is merely pretextual. CVS noted that the UPC is minimized in small print at the bottom of the box and bottle, and Davidoff’s retailers and customers are not made aware of it. CVS also pointed out that Davidoff has never enacted a targeted recall of the type that the UPC system is allegedly designed to facilitate. Thus, CVS contended that Davidoff’s quality control claims were merely pretextual, with the true purpose of the UPC system being to find gray-market goods. The Court rejected these arguments, asserting that retailers and consumers need not be aware of the UPC or its functions.  Rather, the codes were designed to assist Davidoff in effecting quality control and counterfeit detection.  The Second Circuit asserted that Davidoff has the ability to instruct retailers and consumers to assist in anti-counterfeit or quality control measures by looking for the appropriate UPC numbers. 

Further, the Second Circuit stated that the district court properly relied on the testimony of Davidoff’s Vice President for Regulatory Affairs and Quality Assurance, among others, to show that Davidoff had relied on the UPC system to assist with quality issues. The Court held that the fact that none of these instances resulted in a large-scale recall did not help CVS, as an important benefit of the UPC system is that it permits Davidoff to keep its recalls small and targeted.  

The Second Circuit also held that the ability to use the UPC system to identify distributors operating outside the authorized distribution and retail network and importers of gray-market goods does not defeat Davidoff’s claim.  Because Davidoff relies on the UPC for quality control, other effects unrelated to quality control would not negate the legitimate function of the UPC system.

CVS also argued that the injunction was improper because none of its sales of Davidoff products involved inferior products, citing Warner Lambert to assert that the purpose of the injunction was to protect the mark holder against sale of inferior products.  Warner Lambert, 86 F.3d at 7-8 & n.1. The Second Circuit cited El Greco to hold that proof of sale of inferior products is unnecessary. The Court asserted that when analyzing trademark infringement cases involving interference with quality control procedures, the actual quality of the goods is irrelevant.  Rather, the trademark holder is entitled to maintain the control of quality of its goods.  El Greco, 806 F.2d at 395. The Court then held that the goods sold by CVS did involve inferior products because the UPCs were removed by cutting the packaging, applying acids to blur the markings, grinding bottles, and so forth.  The consumer could easily infer that the tampered package was inferior and perhaps suspect it was stolen merchandise, defective, or untrustworthy in some other way.  The Court held that trademarked goods whose luxury packaging is damaged are materially different from those that are intact. Accord Davidoff & CIE, S.A. v. PLD Int’l Corp., 263 F.3d 1297, 1303-04 (11th Cir. 2001). Thus, Davidoff was likely to succeed in its trademark infringement claim because CVS interfered with its quality control procedures and sold Davidoff’s marked goods that were materially different from its genuine trademarked product. 

The Second Circuit held that the sale of gray-market goods which are materially different constituted trademark infringement, citing Original Appalachian Artworks, Inc., 816 F.2d at 73.  Further the Court asserted that the threshold of materiality is lower when comparing the trademark holder’s product with gray-market goods, to include a slight difference which consumers would likely deem relevant when considering purchasing the product. Accord Bourdeau Bros. v. Int’l Trade Comm’n, 444 F.3d 1317, 1323 (Fed. Cir. 2006); Societe des Produits Nestle, S.A. v. Casa Helvetia, Inc., 982 F.2d 633, 641 (1st Cir. 1992)  The Court noted that the damage to the trademarked packaging provides an additional justification, over and above the damage to the trademark holder’s ability to detect counterfeits and to guard against defects, to warrant the grant of the preliminary injunction.

Davidoff is entitled to a presumption of irreparable injury

The Second Circuit held that a plaintiff who establishes that an infringer’s use of its trademark creates a likelihood of consumer confusion generally is entitled to a presumption of irreparable injury.” Weight Watchers Int’l, Inc. v. Luigino’s, Inc., 423 F.3d 137, 144 (2d Cir. 2005).  The Second Circuit affirmed the district court’s finding that Davidoff had established a likelihood of confusion and was thus entitled to this presumption. The Court found that Davidoff’s evidence showed a likelihood that the absence of codes increased the risk that consumers would purchase counterfeit or defective product because of the disabling of Davidoff’s device to actively guard counterfeit or defective products. Thus, the Second Circuit held that there was neither error nor abuse of discretion in the district court’s grant of the preliminary injunction.

Significance to Trademark Owners

The re-importation/re-sale of legally purchased trademarked goods (i.e., gray market goods)  presents an ongoing problem for trademark owners.  In essence, since the gray market good is legitimate, the trademark owner can no longer prevent the distribution and sale of their goods between markets.   While the resale of legally purchased goods is not necessarily illegal as there is no dispute that the goods are authentic, there are mechanisms which a trademark owner can employ which legitimately prevent or restrict the gray market goods.  As demonstrated in Zino Davidoff,  the simple use of indicia (such as unique codes) can be used for legitimate tracking and anti-counterfeit purposes while also preventing an obstacle to the re-sale of goods in different marketplaces.

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