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US Supreme Court Limits Copyright

By Breffni Baggot

How would you react if one of your company's products were exported at a sharp
discount to a foreign sales representative or distributor and suddenly began
reappearing on the U.S. market at prices substantially below the domestic
version of the very same product? It's this kind of nightmare scenario that
may have been brought closer to reality by a recent U.S. Supreme Court
ruling. (1) Export professionals need to be aware of the implications of this
decision regarding "gray market goods," products exported out of the country
that are later re-imported for domestic sale.

If international markets drive sales in the near future, this is not an
issue export managers can
afford to ignore. If your management or legal department is unaware of
the potential threat posed by the ruling, now is the time to call their
attention to it.

Background to Supreme Court Ruling

The Supreme Court ruling regarding gray market goods may add a new facet
to overseas expansion by impacting domestic sales. The Court addressed the
relationship between S.602(a) (2) of the Copyright Act, banning unauthorized
importation of copyrighted material, and the first-sale doctrine of S.109 (3),
which permits the resale of lawfully made copies.

Does S.602(a) create a right to bar all unauthorized importation, as
copyright owners have asserted, or does S.109 limit the reach of S.602(a),
thus permitting the resale of lawfully made imported copies? Discount
retailers and distributors, who often sell budget-priced gray market
items imported from other countries, argued that the importation right
under S.602(a) derives its force from the S.106 distribution right, and
must be subject to the first-sale limitation, as is domestic resale.
The Supreme Court has now decided that copyright law does not protect
companies that export their products from having them shipped back by
another firm for sale in the United States.

Bad Hair Day for California Exporter

The unanimous ruling stated that L'anza Research(Azusa, CA), a company that
sells hair-care products overseas cannot stop another company from buying
those products abroad and reselling them in the United States (4). Once the
copyright owner places a copyrighted item in the stream of commerce by
selling it, he has exhausted his exclusive statutory right to control its
distribution, Justice John Paul Stevens wrote for the Court, reversing the
decision of the
Ninth Circuit Court of Appeals. This reasoning will apply to copyright of
Internet sales; once the "netpreneur" places a copyrighted item in the
stream of commerce by selling it, he has exhausted his copyright.

Labels on L'anza products are copyrighted under federal law. In the United
States, L'anza products are sold only through authorized distributors, such
as beauty salons and barber shops. L'anza also sells its products to
overseas distributors at a discount of 35% to 40% because those
distributors don't benefit from the firm's U.S. advertising. The company,
of course, does not authorize its foreign distributors to import the
products into the United States.

In 1994, L'anza discovered its products being sold at a drugstore in
Carmel, Calif. A distributor in Malta had bought them and sold them to a
New York company, Quality King Distributors(Ronkonkoma, NY), which brought
them back into
the United States to be sold. L'anza sued for a copyright violation, and a
federal judge in Los Angeles awarded it $132,616 and enjoined Quality King
from importing L'anza products for resale.

The Ninth Circuit affirmed the ruling, rejecting Quality King's claim under
a provision in the law that says once a copyrighted product is sold, the
copyright holder cannot keep a buyer from reselling the product. The
Supreme Court, in its reversal, decided that the rule allowing copyrighted
products to be resold without the copyright holder's permission applies to
imported products.

What Are the Stakes for U.S. Exporters?

For a variety of reasons, manufacturers often sell their goods at a steep
discount in foreign markets. The ruling opens the door for distributors to
purchase these American-made products, ship them back to the United States,
undercut domestic prices, and still make a profit. It's important to note
that the ruling only applies to American-made imports, not goods
manufactured abroad.

Not surprisingly, discount merchandising chains support the ruling in favor
of Quality King Distributors. Will these retailers now seek out gray
market distributors in an effort to obtain products at the lowest possible
cost? What impact will this have on companies that currently rely or have
plans to rely on low-priced, American-made exports to fuel sales? Does
significant promotional activity at national and regional retailers provide
evidence that the gray market is already having an impact?

Public policy arguments made before the Supreme Court suggested
that it is unwise to allow importation of American-made goods at
prices that prevent domestic distributors from competing in the domestic
market. The Supreme Court considered such arguments irrelevant to statutory
interpretation. Changes may be proposed to the
Copyright Act to address the concerns of domestic distributors unable to
compete with foreign distributors that import less expensive computers,
pharmaceuticals, and other products. In the meantime,
exporters should review their distribution agreements to see if
they can provide the protection that the Copyright Act cannot.
As a result of this decision, U.S. manufacturers may see their
domestic markets eroded by competition from cheaper re-imported versions of
their own products. In the long term, if it is important for U.S.
manufacturers to maintain wide price disparities between their domestic and
international markets, they may find it necessary to begin manufacturing
their export-only products outside this country. As two of the Justices
noted, the importation of goods made outside the United States could
perhaps be barred under S.602(a) notwithstanding L'Anza, since such goods
would not be "lawfully made under this title" under S.109.
Given the possible effects of the Court's ruling, a legislative
initiative to undo the decision, by amending S.602(a), is likely.
Whether that initiative will succeed, especially in an election year, is
another matter.

Although the L'anza case involved copyrighted labels on shampoo bottles,
S.602(a) was originally aimed at traditional copyrighted works, such
as films, sound recordings and books. If the marketing practices
for exports in those industries are similar to those described in L'anza, there
may be a similar incentive for the development of a gray market
to undercut domestic pricing.

This column is by attorney Breffni Baggot. Mr. Baggot can be
contacted at: Intellectual Property Law, P.O. Box 1215, Manchester, CT
06045-1215; 860-644-6974; fax: 860-644-3477; e-mail: info@patente.com.

FOOTNOTES

1. QUALITY KING DISTRIBUTORS, INC., PETITIONER v. L'ANZA RESEARCH
INTERNATIONAL, INC. (No. 96-1470 US Supreme Court, March 9, 1998).
2. 17 US Code Section 602 (1997)
3. 17 US Code Section 109 (1997)
4. QUALITY KING DISTRIBUTORS, INC., PETITIONER v. L'ANZA RESEARCH
INTERNATIONAL, INC. (No. 96-1470 US Supreme Court, March 9, 1998).


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