Tuesday, May 30, 2017

On Toner Cartridges and Gray Market Imports

The United States Supreme Court has made it easier for discount retailers and "off-brand" Amazon resellers to import and sell refurbished goods, which is good news for bargain seekers.

First, a little background. Intellectual property rights like patents, trademarks, and copyrights are a deal that inventors, artists, and brand innovators make with the United States government. To promote the activity of these creative enterprises, the government grants a limited monopoly on the sale or exploitation of the work. That is why you can't make a copy of Star Wars Rogue One for 95 years, at which time it will fall into the public domain. Similarly, you can't start making your own version of the latest antibiotic because the company that put in the effort on research and development most likely owns the patent.

But, the scope of intellectual property rights is limited. With respect to patents, the law give the patent holder the "right to exclude others from  making, using, offering for sale, or selling" the invention. However, the law includes an exception that applies when the patentee sells the item. At that point, the product is the private individual property of the purchaser, who acquires all the rights of ownership, including the right to re-sell that item. This is why although you can resell your smartphone, you can't reproduce it. The same goes for music files and your trademarked running shoes. This is the rule of exhaustion.

In Impression Products, Inc. v. Lexmark Int'l, Inc., the United States Supreme Court had to decide whether Lexmark could contractually prohibit purchasers of toner cartridges from reselling them. Lexmark did this to keep the cartridges out of the hands of companies like Impression Products, that refurbish, refill, and resell the cartridges at a discount and in direct competition with Lexmark.

To discourage this activity, Lexmark set up two sales channels. In one channel, customers paid "full price" for an unrestricted toner cartridge. In the other channel, called the "Return Program," Lexmark offered a 20% discount in exchange for adding a microchip to the cartridge. The chip contained software that prevent the reuse of the cartridge. In this channel, the purchaser contractually agreed not to transfer the cartridge to anyone other than back to Lexmark. While this was a clever strategy, third parties figured out how to circumvent the chip, allowing the resellers to continue in business.

Lexmark sued Impressions for patent infringement, arguing that it did not acquire the right to use or sell the cartridge. The idea here is not unreasonable. By taking part in the Return Program, the purchaser acquired limited rights and did not acquire the right to resell the cartridge. Under normal principles of commercial law, the purchaser cannot resell more rights than it acquired. Thus, the resale should violate the patent. The Court of Appeals for the Federal Circuit agreed and held in favor of Lexmark.

The Supreme Court, via Chief Justice Roberts, took a different path. The analysis starts with a quotation from 17th Century Lord Coke who said that "in an owner restricts the resale or use of an item after selling it, that restriction 'is voide, because . . . it is against Trade and Traffique, and bargaining and contracting betweene man and man." According to the Court, this is more than an old statement of common law. Rather, it is a principle that Congress has allowed to remain in the patent laws. Without the exhaustion principle, we would not have used car dealers because patentees for individual parts might sue the dealership for repairing and reselling the car and the parts it contains. Consequently, the express reservation of rights by the patentee to the original purchaser does not give the seller a continuing interest in that item.

One additional wrinkle in this case was that some of the cartridges were first sold outside the United States. Thus, the Supreme Court had to decide whether the foreign sale exhausted the U.S. patent rights. Lexmark argued that exhaustion as a result of a foreign sale would interfere with the U.S. market and prevent it from reaping the full value of its patent monopoly. The Supreme Court was unmoved. It said, "the Patent Act does not guarantee a particular price, much less the price from selling to American consumers. Instead, the right to exclude just ensures that the patentee receives one reward--of whatever amount the patentee deems to be 'satisfactory compensation' . . . --for every item that passes outside the scope of the patent monopoly." In other words, Lexmark got paid for those sales outside the U.S. at whatever price it deemed appropriate.

This is the second in a series of Supreme Court victories for parallel importers, also known as gray market importers. The first involved copyrights in textbooks. You can read that here. On the trademark front, the law is more complicated and depends on whether the merchandise is materially different than the products sold in the United States and on whether the trademark was applied outside the United States under the control or ownership of the U.S. trademark holder. If you are interested in that, start here.

Overall, this will permit the free market in the resale of patented goods. That is, as I said, good news for discount retailers and small-scale entrepreneurs. Patentees may adjust quickly, though. The decision makes it clear that this result only applies to sales. If the good is transferred subject to a license and ownership stays with the patentee, then the licensee has no right to resell the item. Expect future toner cartridges to come with license agreements.

Tuesday, May 23, 2017

Nairobi Protocol

The Court of International Trade has taken an interesting hard look at the Nairobi Protocol to the Florence Agreement on the Importation of Educational, Scientific, and Cultural Materials, which is popularly known as just the Nairobi Protocol. For purposes of Sigvaris, Inc. v. United States, the important point is that the Nairobi Protocol permits duty-free entry to the United States for articles that are specially designed or adapted for the use or benefit of the blind or other physically or mentally handicapped persons. The merchandise at issue here is graduated compression hosiery, arm-sleeves, and gauntlets.

The merchandise is all designed to apply a certain amount of pressure the extremities to help prevent the pooling of blood or other fluids as might happen in people with certain vascular and lymph conditions. The hosiery was designed for use by people with early stage chronic venous disease. The arm sleeves and gauntlets were for people with lymphedema, which causes sever swelling in the arms and is common among women who have undergone a mastectomy.

I’m going to jump to the conclusion here. Legally, a person is said to be handicapped if they have a chronic or permanent condition that results in substantial difficulty undertaking the basic activities of life such as caring for one’s self, walking, speaking, seeing, learning or working. People with early stage chronic vascular disease can experience leg fatigue, heaviness in the legs, varicose veins, and swelling. But, 25% of sufferers experience no symptoms and those that experience symptoms do not have trouble completing basic life tasks. Thus, people with early stage chronic vascular disease are not handicapped for purposes of the law. The hosiery, therefore, is not entitled to duty-free entry under the Nairobi Protocol.
The result is different for lymphedema, which is the inability to circulate lymph fluid. It can result in pain, swelling, and ulcerations. The swelling can be so severe that it results in the inability of the patient to use the affected arm. That is, according to the Court, a handicap. As a result, the compression arm sleeves and gauntlets qualify for duty-free entry under the Nairobi protocol.
That is all well and good. It makes perfect sense and is a good analysis for anyone thinking of using the Nairobi Protocol.

Despite that, I keep returning to a single line in the decision. That line states: “The Court does not give credible weight to the Government’s assertion that a person with one arm is able to perform life’s major activities without substantial limitation.”
I don’t think I have ever written a blog post in which I have criticized a lawyer’s argument. I am hesitant to do so here. But, I really want to explore how that argument got into the briefs. I understand the factually correct assertion that people with one arm are fully capable of independent living. Two things about that fact, though, bear consideration. First, much of that independence may be facilitated by apparatus that would qualify for duty-free entry under the Nairobi Protocol. This would be true, for example, of prosthetic limbs (but not parts thereof). The existence of other Nairobi Protocol material should not undercut the ability of these products to qualify for duty-free importation.

Assuming the argument was that a person with one arm can live and work independently without any mechanical or other technological support, one should wonder what evidence for this proposition the Government provided.
Let’s be 100% clear. I am in no way, shape, or form implying that people with a physical challenge cannot live independent lives without external support. I am also not saying that there are no examples of successful and independent one-armed people. There are. All I am saying, and all the Court said, is that it is not credible to argue that a person with one arm does not have a permanent condition that causes substantial difficulty completing basic life tasks. As I type this post in the cramped quarters of American Airlines coach class, I am struck by the difficulty presented by the prospect of typing with one hand. Dragging a suitcase through an airport with only one arm would make it impossible to simultaneously use a smart phone or carry a drink in the other hand, as is the ubiquitous condition in modern airports. Riding a bike can be done with one hand, but two is far easier and safer. While I think I could drive easily with one arm, I learned just yesterday that I can barely change a tire with two perfectly good arms when one lug bolt is 80% stripped (but that is another story). I am sure that monitoring my daily activities would lead to a long list of tasks that would be far more difficult without two good arms.

My question about this stands: how did it get into the brief? Giving everyone the benefit of the doubt, was there some more subtle argument that was not well conveyed in the opinion? The opinion is thorough, so that does not seem to be the case. Was it the best argument available given the fact that lymphedema sometimes results in the inability to use an arm? If so, did the Department of Justice just go along with Customs and Border Protection’s views?
This matters because it goes to the nature of the relationship between lawyers and clients and to the public policy of the United States. Lawyers sometimes need to tell their clients that the best argument is not good enough, that the law does not support the reality the client wants. That can be a hard conversation, but hard conversations are part of the job. This is, I think, true for all lawyers but especially so for those lawyers who have the privilege of representing the United States government. While a private party, with a purely financial interest in securing a duty refund, might take a shot at a weak argument, the United States should be pursuing arguments that support the policy objectives of the United States while also preserving and protecting the revenue. It is hard to see how proffering the argument that having one good arm is not a handicap that merits the relatively minor impact on the American economy of duty-free access to the market is good public policy.

I would be very happy to be talked out this position. Is there some issue of international harmonization at stake? Is there some evidence of actual fraud? If you have insight into the reasoning, please drop a comment.

Wednesday, May 17, 2017

The "It's May? I Better Catch Up" Edition

There have not been many specifically customs-related cases from the courts of late. There have been plenty of rulings, in fact there have been rulings every week. I just have not had a chance to blog them. That is why things have been slow here. I have been tossing out the occasional tweet on agency actions and newsworthy developments. If you are not doing so already, please follow my Twitter feed @customslawblog or check it in the box on this page.

In the meantime, the Court of International Trade issued an opinion in United States v. International Trading Services. This decision is fairly uncomplicated decision the defendant in this penalty case failed to show up and defend itself. If you recall the earlier decision in this matter, you will understand why. The corporate client dissolved, leaving the lawyer, in his mind, without a client to represent. The lawyer tried to formally withdraw from the case but was rebuffed by the Court which held that the legal entity remained subject to suit under Florida law and, therefore, still needs a lawyer.

The underlying penalty here has to do with the incorrect classification of sugar on eight entries. The error resulted in just under $300 thousand in unpaid duties. The United States, on behalf of Customs and Border Protection, moved to collect the duties and a penalty of two times the unpaid amount. The defendant did not respond. As result, there was no real doubt that the Court would impose a penalty. The question was how much.

This is a good decision to read because it very logically walks through the process the Court of International Trade undertakes to assess a penalty. The first question is whether there was a material false statement or omission in connection with the entry of merchandise. A statement or omission is material if it would tend to alter Customs' appraisement or the importer's liability for duties. An incorrect classification that results in the underpayment of duty is material. Once the Court identifies a material false statement or omission, the defendant has the burden of proving that it did not result from negligence, gross negligence or fraud. As the defendants did not respond, the facts asserted in the motion are treated as true. That means there was no question as to liability.

Customs was seeking to recover about $691 thousand in penalties. But, setting the penalty amount is the responsibility of the judge, not Customs. The Court, therefore, walked through the 14 factors set out in a case called Complex Machine Works, which is worth a read for background. Here, Judge Barnett took the very helpful step of grouping those 14 factors into five broader categories. Those are:


  1. The defendant's character
  2. The seriousness of the offense
  3. The practical effect of the imposition of the penalty
  4. The economic benefit gained by the defendant
  5. Public policy concerns
The Court made a couple very important points. First and foremost is that the statutory maximum is not the default starting point for the penalty. The Court must consider the case on a clean plate. Starting at the maximum stacks the deck against the defendant by forcing it to argue down from the most severe penalty rather than having the Court consider the evidence to reach an appropriate result. The Court suggests starting at the midpoint and adjusting up or down as the evidence indicates.

Next, regarding cooperation, potential defendants should recognize that this is more than being pleasant through the course of the investigation. Customs' guidelines suggest mitigation where the defendant has exhibited "extraordinary cooperation beyond that expected from a person under investigation." Note that the CBP guidelines are not binding on the Court, although it did note their existence and apparently gave them some weight.

Related to this, the Court undercut somewhat the common argument that an importer had prior good behavior. This case involved eight separate entries. The Court characterizes this as defendant "serially misclassif[ying] entries accruing to Defendants a significant economic benefit." Does this mean that only the first entry would benefit from prior good behavior? My concern here is that in many cases the importer would not know about the error until several, possibly many, entries took place. Most errors are systematic in nature, not individual. My inclination would be to treat the error as the substantive decision rather than the entry and extend the benefit of good behavior regardless of the number of entries involved. Of course, that is only one of 14 factors, so the impact may be minimal.

Taking all of this into consideration, the Court found the maximum penalty to be appropriate. On top of that, the Court found it appropriate to grant prejudgment interest to the United States.