Friday, August 27, 2010

Court reduces $10 million false advertising award to half a million

National Products, Inc. v. Gamber-Johnson LLC (W.D. Wash. 2010)

Seattle Trademark Lawyer has been following the case. Gamber-Johnson lost a trial about its comparative advertising about the parties’ emergency vehicle laptop mounting systems. It moved for and received judgment as a matter of law on damages, reducing the jury’s $10 million award to a little under $500,000. NPI received a permanent injunction and attorneys’ fees and costs, but not prejudgment interest.

A jury verdict will be upheld if supported by substantial evidence, though the district court has discretionary power to modify monetary awards under the Lanham Act, which are “subject to the principles of equity.” 15 U.S.C. § 1117(a). The Lanham Act allows (1) disgorgement of defendant’s profits; (2) plaintiff’s actual damages (lost sales); and (3) the cost of the action. The court can increase damages up to three times actual damages found and can only decrease them if the award wasn’t based on substantial evidence, but it can adjust profit awards “according to the circumstances of the case” if the initial award is inadequate or excessive, as long as its award constitutes “compensation and not a penalty.”

Here, NPI didn’t seek actual damages, so its theory was based on unjust enrichment/disgorgement of profits. Relief is not a matter of right and must be based on the totality of the circumstances, avoiding a windfall to the plaintiff and pure punishment for the defendant: actual evidence of injury is the touchstone. But the court also needed to take into account the jury’s finding that Gamber-Johnson deliberately engaged in false advertising.

NPI was entitled to a presumption of actual deception and reliance because Gamber-Johnson’s statements were intentionally false/misleading. The presumption of damages, however, didn’t extend to sales diversion. NPI disavowed reliance on injury to goodwill and reputation in its post-trial motions on damages. Because it wasn’t claiming actual damages, it had to prove that it was entitled to any profits Gamber-Johnson earned that were attributable to the false advertising. At that point, the burden would shift to Gamber-Johnson to prove its expenses and profits attributable to factors other than false advertising.

The problem was that there was a dearth of evidence proving that all Gamber-Johnson’s sales and profits during the relevant period were attributable to false advertising. After trial, the court requested evidence from NPI connecting the false video to the profits, and NPI responded with evidence from trial proving that at least two companies chose to purchase the Gamber-Johnson product after reviewing the video. But NPI never offered any evidence at trial quantifying Gamber-Johnson’s profits from those sales, and considering evidence outside the trial record was improper. Without evidence of profits attributable to those sales, the court couldn’t award damages based on Gamber-Johnson’s profits from those sales.

NPI’s expert witness opined that Gamber-Johnson’s profits during the relevant period were $22,570,826. However, his analysis of how much was attributable to false advertising was based on anecdotal evidence about unidentified customers. The court couldn’t connect his calculations to the jury verdict of $10 million, despite NPI’s argument that one could use the profit margin offered by Gamber-Johnson (nearly 30%) on revenue of $54 million, plus “a few additional deductions,” to reach that figure. Gamber-Johnson’s expert testified that the best indication of its profits from sales diverted from NPI was approximately $350,000. Using a higher profit margin estimate as posited by NPI, the court calculated that an award of nearly $500,000 “would serve the policy considerations behind the Lanham Act.” Even though other vendors were mentioned in the video and some of Gamber-Johnson’s profits therefore probably didn’t represent sales taken from NPI, equity—including the jury’s finding of Gamber-Johnson’s intent—supported the award.

NPI argued that its burden was simply to identify the pool of sales attributable or related to the false advertising, and that it had done so by identifying the sales of the falsely advertised goods. The court disagreed. It’s necessary to segregate profits from sales associated with the infringing/false activity from sales that don’t involve infringement/falsity. Another infringement case involved a presumption that profits from jeans bearing a counterfeit Playboy mark were attributable to the infringing mark. But unlike that case, where every purchaser would have seen the infringing mark, the evidence here was that only some of Gamber-Johnson’s customers would have even seen the video, so NPI needed more evidence.

NPI was still entitled to a permanent injunction. NPI wanted it to include a requirement that Gamber-Johnson notify everyone to whom it had sent the video that the statements in the video are false. Gamber-Johnson argued that injunction was unnecessary because it already ceased distribution. But it admitted that it never attempted to retract any copies and still encouraged its distributors to use the video. The only question was how much activity to enjoin. Gamber-Johnson argued that explicit notification about the falsity was unnecessary, but the court was “concerned that Gamber-Johnson continues to assert that the statements in the video were not false and thus it was not going to publicize the jury’s findings.”

Thus, the court ordered Gamber-Johnson to send by first class mail a copy of the jury’s findings in this case to each of the vendors or distributors that received the video.

NPI also got a fee award because the jury’s finding that Gamber-Johnson’s false advertising was deliberate naturally supported a finding that this was an exceptional case under 15 U.S.C. § 1117(a). The court denied prejudgment interest because that’s for cases in which the plaintiff won’t be made whole without additional compensation, and NPI didn’t meet that standard (though I’m not really clear why).

Not a close shave: Gillette class action settlement wins preliminary approval

In re M3 Power Razor System Marketing & Sales Practice Litigation, 2010 WL 3082198 (D. Mass.)

This is a consolidated class action over alleged misrepresentation by Gilette in marketing its M3P razors. The court allowed notice of a proposed settlement to go out to a North American class (including Canada). The only objector was a California plaintiff. The court found a sufficient basis to hold that: (1) questions of law and fact common to the class members predominate; (2) the class representatives align generally with the class as a whole and its constituent parts; (3) there is no unfairness in treating similarly class settlement members drawn from multiple jurisdictions with diverse legal regimes; and (4) the settlement resolution is adequate.

Given the common claim based on uniform marketing representations, the court concluded that class certification was appropriate in the absence of "variations in state laws ... so significant as to defeat commonality and predominance, even in a settlement class." Sullivan v. DB Invs., Inc., --- F.3d ----, 2010 WL 2736947, at *14 n. 15 (3d Cir. July 13, 2010). Here, all class members asserted a claim under Massachusett’s Unfair and Deceptive Practices Act, ch. 93A, on the ground that the allegedly deceptive communications originated from Gillette's Massachusetts-based headquarters.

Gillette advertised the M3P battery-powered oscillating head as "revolutionary" in its ability to raise hair up and away from the skin. All the representative plaintiffs claimed to rely on this, bu the M3P didn’t actually raise hair up and away from the skin. Gillette’s primary competitor Schick sued for false advertising around the world. Courts in France, Belgium, and the Netherlands refused to enjoin the disputed advertising, but courts in the U.S. (D. Conn.), Germany and Australia issued preliminary injunctions. After extensive U.S. discovery, with Gillette and Schick reached a worldwide settlement. But class action litigation followed in several states and Canadian jurisdictions; all the state cases were removed and all the federal cases were transferred to the Massachusetts district court and consolidated.

The proposed settlement would establish a $7.5 million settlement fund, up to $2.45 million of which could be used to provide notice. Any notice costs over this amount would be borne by Gillette. Participating class members could get a refund if they returned the razor (not the blade or batteries) and certify that it was purchased or acquired during the class period; they’d get $15, unless they could document a higher actual purchase price (with $2 for postage). Class members who keep or don’t have the razor any more can get up to 2 $5 rebates for any purchase of M3P blades purchased after May 2004, and/or a Gillette Fusion razor or a Fusion ProGlide razor purchased after January 2006, by submitting relevant documentation. If refunds and rebates exceed the allocated settlement fund, each class member gets a pro rata share. If the settlement fund isn’t exhausted after the initial claim period, class members who submitted an approved claim will also get a new Fusion razor (or a statistically random sample if mailing a razor to everyone, at a $7 credit per razor, would exceed the fund).

If that doesn’t do it, Gillette will add a link to the M3P razor webpage inviting class members who haven’t previously submitted a claim to do so. The documentation requirements will be relaxed; after certifying that he or she purchased or got an M3P razor during the class period, the class member will get a free Fusion razor, debiting the settlement fund $7. This will last 90 days or until all funds are distributed, whichever comes first. If that doesn’t exhaust the fund, then Gillette will distribute free Fusion razors to a group selected by the parties until the fund is gone.

In addition to the settlement fund, Gillette agreed to pay up to $1.85 million, subject to court approval, for attorneys’ fees, as well as $500-$1000 incentive awards to the representative and named plaintiffs.

The court found that Rule 23(a)’s requirements of numerosity, commonality, typicality, and adequacy of representation were satisfied, even under the heightened scrutiny required to protect absent class members. Gillette sold over 10 million razors in the relevant period, and didn’t maintain purchaser records, and the individual claims were relatively small. Common core questions were at the heart of the litigation: whether Gillette misrepresented the razors, whether this caused damage, and how much damage was at issue. The class representatives’ claims arose from the same ads and were based on the same legal theory as those of the class. Most counts were based on common law causes of action (negligent misrepresentation, intentional misrepresentation, breach of express warranty, breach of implied warranty of fitness of purpose, and unjust enrichment), which would be substantially uniform across the class. Though the representative plaintiffs weren’t residents of each covered state, the consumer protection statutes in their states of residence (Florida, New York, California, Massachusetts, Illinois, Georgia and Canada) “appeared to be typical of, and generally even more consumer-friendly than, consumer protection laws in the range of jurisdictions that they represent.” Finally, the representative plaintiffs’ interests aligned with the class as a whole, and appointed counsel had “performed in a highly competent and professional manner.”

The next issue was Rule 23(b); the court found that Rule 23(b)(3) applied, which allows class certification if “the court finds that the questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy.” Superiority was easy, given the large numbers and small individual claims and that the forum jurisdiction was familiar with Chapter 93A, which applied to the Massachusetts corporate defendant.

Predominance overlaps with commonality and tests whether proposed classes are sufficiently cohesive to justify class representation. The court found predominance clear: the dominant common questions included whether Gillette's advertising was false or misleading, whether the company's conduct violated the statutory and/or common law causes of action at issue, and whether the class members suffered damages as a result of this conduct. “Even if state consumer statutes or other state causes of action differ in arguably material ways, common questions, not individual issues, predominate among and within each state's legal regimes.”

The objecting plaintiff argued that the proposed settlement was insufficiently generous to potential California class members, because California’s laws are more stringent. The court considered subclassing as a response, though subclassing shouldn’t be done lightly because it inherently reduces efficiency and increases transaction costs, particularly for notice. The court considered (1) the significance of variations in state law; (2) the differences between California and Massachusetts/other laws; and (3) the magnitude of such differences.

Legal variations can sometimes require individualized factual determinations and undermine the class’s ability to show commonality. They can also create conflicts of interest and allocation dilemmas. Thus, courts have required rigorous analysis of state law variations, but must also remain sensitive to the common core of issues.

Taking California first: the evidentiary standard for awarding restitution and actual damages is demanding. The Gillette case has valuation difficulties because Gillette produced evidence that consumers preferred the M3P razor, even if it did not perform exactly as advertised, and because the precise value of having one's hair raised "up and away" during a shave is inherently speculative. As a result, it was unlikely that a court applying California law in a California state class action would award restitution here. Likewise, punitive damages were unlikely even in a clear-cut liability case, and here courts around the world divided, at least initially, over whether Gillette’s conduct was even actionable. Moreover, since 2004’s referendum, California’s procedural and substantive consumer protection law became less consumer-friendly. Its class action law is currently very similar to Massachusetts law, as indicated by similar treatment of a putative class of Listerine purchasers suing over the same alleged misrepresentations.

Indeed, Chapter 93A is quite robust and arguably more consumer friendly than California law. Unlike the UCL, Chapter 93A does not require reliance, only a tendency to deceive. Materiality and causation can be established by showing that the deceptive representation "could reasonably be found to have caused a person to act differently from the way he [or she] otherwise would have acted." Compensatory damages are available even without intentional misrepresentation, which in a class action provides restitution, and exemplary damages from two to three times actual damages can also be awarded.

As for other jurisdictions, “[a]fter extended review of the various legal regimes,” the court found that the plaintiffs “have demonstrated that, although variations in state law exist, they do not overcome the common factual and legal issues shared by the potential class members. The only purported distinctions actually argued by an objector--those presented by California consumer protection law--are, to the extent they are significant at all, differences of degree, not of kind, and are not substantial and clear-cut enough to require a subclass.”

Objecting plaintiff Corrales argued that California consumers paid more for their M3P razors and that differences between California law and that of other jurisdictions created conflicts of interest requiring separate treatment. On the first point, Corrales had no reliable evidence, and anyway the settlement allowed class members to recover more if they had receipts. Nor did California law introduce significant difficulties for the international class. All the plaintiffs had the motivation to establish the same legal and factual elements. The available remedies were similar for everyone. The possible conflict was minimal and speculative because of the relatively small differences in damages/potential remedies.

“Especially given the commonality of the Chapter 93A claim for all class members, there are no particular advantages or disadvantages applicable to class members in any of the several jurisdictions and consequently no potential for conflicts of interest.” Inclusion of a Canadian class was somewhat unusual, but still didn’t produce conflicts, as Canada would recognize the court’s judgment.

The court then preliminarily approved the settlement, which requires a finding that it is fair, reasonable, and adequate. Factors for assessing reasonableness when the settlement occurred in lieu of litigation include whether "(1) the negotiations occurred at arm's length; (2) there was sufficient discovery; (3) the proponents of the settlement are experienced in similar litigation; and (4) only a small fraction of the class objected." The court was satisfied that these factors favored approval. The revised proposed settlement was more favorable to class members than Gillette’s initial response to pre-suit demand letters, which among other things didn’t require Gillette to provide a floor for the recovery and required consumers to return the razor to obtain a benefit. This was important because everyone agreed that redemption rates are likely to be low. Gillette produced over 100,000 pages from the litigation against Schick, “allowing the parties to acquire enough information rapidly to make serious settlement negotiations feasible.”

The court did require that the website providing notice to class members had to contain the proponents’ joint submission comparing the relevant state laws, along with the court’s memorandum and order, thus “alerting class members to the issues presented by the varying state law causes of action and remedies available to the class members. In this way, class members who may wish to learn more about those alternatives and consider their implications will have a foundation for doing so.” With that, notice could proceed.

Thursday, August 26, 2010

Home might be a castle, but not an identity

Robinson v. HSBC Bank USA, 2010 WL 3155833 (N.D. Cal.)

HSBC ran a full-page, double-sided print advertisement in the San Francisco Chronicle which prominently features a photograph of the "street-facing side" of plaintiffs' house, a picturesque Victorian home in the Haight with a distinctive bright yellow and green exterior. On the first page of the Ad, there is a photograph showing the second and third stories of two Victorian homes. Tagged onto the photograph are the words "A Mortgage To Match Your Ambitions. Wherever The World Takes You." On the back of the ad, HSBC advertised its "Premier Mortgage," giving details of the offer and HSBC's contact information. The ad "identifies the precise longitudinal plane on which" plaintiffs' property is situated. The back of the ad contained another, smaller, cropped picture of the top floor and roof-line of three houses, including plaintiffs' property. Plaintiffs alleged that the mortgage on the property was paid off long ago, and that they are not and never have been HSBC customers.

After the ad ran, the Robinsons began to get inquiries from neighbors, realtors, and tenants who live in the property about their financial condition and their willingness to sell. They alleged that HSBC’s conduct was highly offensive because it falsely implied that they had an HSBC mortgage and endorse/approve of HSBC’s products or services, which is particularly galling in the current economy because of the financial harms inflicted by adjustable-rate loans like those advertised in the ad.

The court first ruled that plaintiffs’ claims weren’t preempted by the Copyright Act. Though the Act specifically addresses photographs of architecture taken from public places, it does so to exempt them from coverage. Because plaintiffs couldn’t have asserted an infringement claim with respect to pictures of their property taken from a public place, the interests they sought to protect didn’t fall within the subject matter of the Copyright Act, and the rights asserted weren’t equivalent to copyright. Many courts have held that statutory and common-law misappropriation of likeness claims are not preempted. (As usual, defendants argued express preemption when conflict preemption would have been a better conceptual fit, though here I think conflict preemption is also a loser.)

Plaintiffs lost as to the substance of their claims, however. They failed to state a claim for misappropriation. They couldn’t state a statutory cause of action, since the California statute only covers “name, voice, signature, photograph, or likeness.” The likeness of the property doesn’t count. They also couldn’t state a common-law cause of action, which required a bit more in the way of fancy footwork. Plaintiffs alleged that they were easily identifiable by the notoriety of the property (a unique building with distinctive molding and fixtures). They relied on Motschenbacher, which upheld a misappropriation by a race car driver whose distinctive car (slightly modified) appeared in an ad. In Midler, the Ninth Circuit restated the holding as follows: "California will recognize an injury from 'an appropriation of the attributes of one's identity.' ... It was irrelevant that Motschenbacher could not be identified in the ad. The ad suggested that it was he. The ad did so by emphasizing signs or symbols associated with him."

The court here held that the allegations didn’t rise to the level of those in Motschenbacher or Midler. In each case, the court found that the car/voice was “immediately recognizable.” “Plaintiffs' allegation that their house is so recognizable that after the Ad ran they received inquiries from friends and strangers regarding their financial solvency and intentions with respect to the house because they were known as the owners of the home by neighbors and realtors, does not mean that plaintiffs' identities were appropriated by HSBC.” Okay … but why? Well, says the court, the property isn’t part of their identity. They didn’t construct or design it. Instead, plaintiffs are simply the owner/occupants of a very distinctive building.

Questions: Does the designer/builder have a misappropriation claim? For that matter, did Midler design her voice? I don’t recall courts relying on the idea that Motschenbacher designed his car; and Kozinski’s White dissent pointed out that Vanna White didn’t design her costumes, jewelry, and setting. I understand the impulse, but this is why misappropriation is such a bad cause of action: lacking any internal constraints, courts just invent new ones when they think they should. Anyway, how come the court gets to tell plaintiffs what’s part of their identity? In a footnote, the court agreed that if plaintiffs sold and moved out of the property, the property would still retain its notoriety but would no longer be identified with them, whereas if Motschenbacher sold his car it would still be part of his identity. So it’s not really identity, it’s public reputation, I guess. Here, the house has a greater public reputation than the plaintiffs, so they can’t win.

Likewise, plaintiffs failed to state a claim for trade libel, which is an intentional disparagement of the quality of property which results in pecuniary damage to plaintiff. HSBC argued that there was no falsity because there was no direct statement about the property or plaintiffs’ financial situation. Plaintiffs argued that the ad was "a malicious implication" that they were financially insolvent or "are in need of a mortgage because their ambitions are disproportionate to their assets." And the ad was false because HSBC knew, or should have known, that "Plaintiffs do not hold or need an HSBC mortgage on the [ ] Property and that they have never done business with HSBC." The court found that, on the facts alleged, the ad didn’t create a false and disparaging implication of fact. Among other things, an allegation that someone has a mortgage, even an ARM, isn’t defamatory or disparaging. The ad wasn’t a “for sale” ad, an ad for foreclosure bargains, or anything like that. “The Ad is not susceptible to the meaning suggested by plaintiffs, i.e., that they are financially insolvent or their ambitions are disproportionate to their assets.”

Likewise, plaintiffs failed to plead special damages, as required for trade libel (as opposed to defamation). Contempt, ridicule, and pity, along with doubt about their financial solvency, don’t suffice to show pecuniary harm. Nor does the cost of legal representation, since counting that would make special damages automatic.

The court then ruled that there is no stand-alone action for unjust enrichment in California, absent some other cause of action.

Nor did the CLRA help, because this case didn’t involve any consumer transaction to which plaintiffs were a party. The California False Advertising Law claims failed too. “Plaintiffs do not argue that there is anything false or misleading about the text or services being offered by HSBC in the Ad. Instead, plaintiffs' complaint is that they were disparaged by the juxtaposition of the text of the Ad with the photos of their Property, but that is not a false advertising claim.” Without the other causes of action, there was nothing unlawful under the UCL, and without falsity, there was nothing fraudulent. Plaintiffs’ only hope was that the ad was “unfair.”

But plaintiffs only had standing if they’d lost money or property as a result of HSBC’s conduct. And the complaint did not allege this, other than that they’d spent money on the lawsuit, which doesn’t count. Ridicule and questions about solvency aren’t lost money or property. Moreover, the court doubted that plaintiffs would be entitled to any remedy, since the UCL only allows restitution. Since plaintiffs aren’t HSBC customers, there are no funds to return to them; they can’t seek disgorgement of ill-gotten gains through the UCL. And injunctive relief was unlikely to be necessary, “as the Court doubts HSBC is going to use another picture of plaintiffs' Property in a future ad.” (Though it apparently has every right to do so.)

Moreover, even if there were standing, the court seriously doubted that the challenged practice was “unfair” within the meaning of the UCL. There are two approaches to unfairness: (1) the plaintiff has to show that consumer harm outweighs utility; (2) the plaintiff has to show that the practice violates public policy as declared by “specific constitutional, statutory or regulatory provisions.” Plaintiffs didn’t sufficiently allege unfairness, only that the ad allowed HSBC “to gain an unfair competitive advantage over law-abiding financial institutions and banks.” But they didn’t explain how using photographs of properties taken in public for non-defamatory advertisements, even without the permission of the property owners, harms consumers or confers an unfair benefit on HSBC.

eBay applied to false advertising injunction

Schering-Plough Healthcare Prods., Inc. v. Neutrogena Corp., D. Del. Aug. 20, 2010

Neutrogena falsely advertised the presence of Helioplex in certain of its sunscreens. But Schering-Plough was not entitled to a permanent injunction based on a presumption of irreparable harm; it had to satisfy the eBay factors. Although in an E.D. Va. case, PBM v. Mead Johnson, the court granted a permanent injunction on the theory that a jury verdict could presumptively satisfy the irreparable injury factor, the court still applied eBay. The same is true of the recent Osmose case, which inferred harm from the seriousness of the claims at issue. Thus, the parties were allowed limited discovery addressed to the four permanent injunction factors (irreparable injury; legal remedies such as damages inadequate; balance of hardships; public interest).

Wednesday, August 25, 2010

Buyer of allegedly infringing goods lacks standing against seller

Kam Lee Yuen Trading Co. v. Hocean, Inc., 2010 WL 3155812 (N.D. Cal.)

Plaintiff KLY and Hocean are wholesalers specializing in Asian foods. In 2009, Aik Cheong Neo brought an action against KLY, Hocean, supermarket chain Welcome Market, Inc., and nineteen other wholesalers, distributors, and retailers alleging infringement of his IP rights in the design and packaging of a mushroom seasoning. Hocean allegedly sold KLY infringing mushroom seasoning, which Welcome Market then sold to its customers. Welcome demanded that KLY reimburse it for its defense costs, which KLY did because Welcome was KLY’s largest customer. Welcome hired Latham & Watkins and counterclaimed to cancel Neo’s trademark registration, along with asserting other defenses. Neo ultimately dismissed all his claims with prejudice. KLY reimbursed Welcome $153,000.

KLY then sued Hocean to recover those costs, claiming that Hocean’s mushroom seasoning had packaging and labeling that infringed "and/or constituted false designation of origin of [Neo's] mushroom seasoning," in violation of Section 43(a)(1) of the Lanham Act. The court found that KLY lacked standing to bring a trademark infringement claim because it had no interest in Neo’s mark. KLY argued that it was bringing a false advertising claim instead. In the 9th Circuit, §43(a)(1)(A) and (a)(1)(B) have different standing requirements. For (A), the plaintiff must allege "commercial injury based upon the deceptive use of a trademark or its equivalent to satisfy standing requirements," and a "commercial interest in the product wrongfully identified.” For (B), a plaintiff must claim a "discernibly competitive injury."

Moreover, §43(a)(1) claims aren’t allowed if they would “indirectly eviscerate” the standing requirements of other causes of action—that is, no private cause of action for violating the FDCA. Similarly, the 9th Circuit barred a Lanham Act claim that would require litigating an underlying copyright infringement claim where the plaintiff lacked standing to bring the infringement claim. KLY argued that it had suffered commercial injury, and that its past possessory interest in the allegedly infringing product was a sufficient commercial interest.

The court thought that KLY’s argument over its injury “would eviscerate the standing limitations Congress established for bringing a Lanham Act trademark infringement action” (though of course it is the courts, not Congress, that created current standing doctrine, as the court had just stated). The case law doesn’t support allowing false association claims premised on infringement of a third party’s mark. In Sybersound, the copyright case, plaintiff and defendants were competitors that produced and sold karaoke records to distributors. Plaintiff claimed that defendants produced karaoke records without purchasing the necessary licenses from copyright holders, which put the plaintiff at a competitive disadvantage. The 9th Circuit held that "[c]onstruing the Lanham Act to cover misrepresentations about copyright licensing status ... would allow competitors engaged in the distribution of copyrightable materials to litigate the underlying copyright infringement when they have no standing to do so." A similar rationale applied here. KLY’s injury couldn’t be severed from the underlying trademark infringement action: to prove that Hocean caused KLY’s harm, KLY would have to prove Neo’s case.

The court also held that it would reach the same conclusion other under standing tests such as Conte Bros./Phoenix of Broward. KLY’s injury was not of the sort the Lanham Act is designed to remedy, such as lost sales/goodwill. This was not a dispute between two competitors, but a dispute between a buyer and seller over the quality of a good. State commercial law is the proper remedy.

Banking on unfairness: $203 million verdict against Wells Fargo

Gutierrez v. Wells Fargo Bank, N.A., --- F.Supp.2d ----, 2010 WL 3155934 (N.D. Cal.)

This decision finds that Wells Fargo’s unfair and fraudulent business practices generated hundreds of millions of dollars in overdraft fees. My extremely long recap leaves a lot out, though the facts are well worth reading if you want to see how a big institution squeezes profits out of its most vulnerable customers. (My first draft said "decides to squeeze," but I think that's wrong: with one exception, nobody at the bank seems to have decided to do this, only debated how it could best be done.) As the court said:

Overdraft fees are the second-largest source of revenue for Wells Fargo's consumer deposits group, the division of the bank dedicated to providing customers with checking accounts, savings accounts, and debit cards. The revenue generated from these fees has been massive. In California alone, Wells Fargo assessed over $1.4 billion in overdraft penalties between 2005 and 2007.

Wells Fargo currently charges $35 for a single overdraft, an amount not in dispute. The problem was that Wells Fargo devised a bookkeeping device to turn one overdraft into as many as ten. “The draconian impact of this bookkeeping device has then been exacerbated through closely allied practices specifically ‘engineered’--as the bank put it--to multiply the adverse impact of this bookkeeping device.” As predicted, these “neat tricks” generated “colossal sums.” “The bank went to considerable effort to hide these manipulations while constructing a facade of phony disclosure.” The court enjoined these practices for the certified class of California depositors and ordered restitution.

In April 2001, Wells Fargo switched from low-to-high to high-to-low posting (reconciling deposits and withdrawals in the wee hours of the morning). The court found that Wells Fargo did so in order to maximize overdraft fees. Wells Fargo, unlike what most other institutions did and still do, started with the highest amount, deducted it from the depositor’s account, and proceeded down the list. So, a consumer who just barely overdrafted her $100 account with 10 $2 purchases and one $100 purchase would have paid one overdraft fee under the old system, and 10 under the new system; plus after a few overdrafts she would be kicked up into a higher penalty category, paying even more. (Ten was the bank’s voluntary limit.) The class representatives included plaintiffs whose experiences approached the theoretical limit and who had thus literally paid over $30 for a cup of coffee.

Compared to its previous practices, this produced—as the bank intended—substantially more overdrafts, especially because Wells Fargo combined this with two other changes. Initially, Wells Fargo had segregated debit card transactions from checks and automated recurring charges authorized by consumers—as to which consumers might have good reasons to want the transactions to have priority of payment. Missing a mortgage payment or having a check to the IRS declined could have much worse consequences than a couple of overdraft fees. By comminging debit card transactions with checks and automated charges and then going high-to-low, Wells Fargo amplified the overdraft-multiplying effect of high-to-low, with no corresponding consumer benefit.

Wells Fargo engaged in further “engineering”—its own term—by creating a secret “shadow line” in May 2002 to authorize debit card purchases into overdrafts. Previously, Wells Fargo declined debit card purchases at the point of purchase when the account balance was insufficient. The new shadow line was an undisclosed line of credit, meaning that customers’ debit cards would not be declined even if overdrawn, and they’d have no warning that an overdraft was in progress. The extent of the shadow line varied by customer according to Wells Fargo’s assessment of the likelihood that they’d pay the overdraft fees. Wells Fargo “correctly expected that it would make more money in overdraft fees than it would ever lose due to ‘uncollectibles’ (i.e., overdrafts that were never paid back).”

The representative plaintiffs were new to banking; they incurred massive overdraft charges that would have been hundreds of dollars lower under Wells Fargo’s prior practices. Wells Fargo took the position that customers should have been using check registers to protect themselves. The problem is that, even had customers been doing this (which Wells Fargo well knew they would not), a check register tracks transactions in the order in which the customer engages in them, not in high-to-low order. “In reality, the most exacting register would not have told Ms. Gutierrez that she would be hit with four rather than one overdraft fee.”

Nor did Wells Fargo indicate in its statements, or with its online system, how the actual transactions had been processed. The court found as a fact that consumers could not have figured out what had happened to them: “The Court has studied [Gutierrez’s] account statements and finds that it was impossible for her or anyone else to reconstruct how the bank came up with its number of overdrafts.” Indeed, it seems that it took significant forensic accounting to figure out what had gone on in this case. Wells Fargo’s fine print disclosures (over 100 pages, 10-point font) said that it could post transactions in any order it wanted, not that it was going to do so in a way that would maximize overdraft fees.

The court found that Gutierrez was deceived by the bank’s “obfuscation” of its high-to-low posting practice, and that she relied upon the bank’s “misleading marketing materials that reinforced her natural assumption that debit-card transactions would post chronologically.”

The other named class member, also new to banking, had a depressingly similar story. Among other things, the bank used the shadow line to authorize an overdraft on a debit card purchase after it had already mailed out a deficiency notice and assessed $413 in overdraft fees (on an overdraft of a hair more than $100). She was ultimately assessed $506 in penalties for $120 in overdrafts; some of that wasn’t directly tied to high-to-low posting, but high-to-low posting increased the number of fees and kept her in overdraft longer, triggering additional fees.

The court found that Wells Fargo’s actual motive and purpose was “profiteering.” “Internal bank memos and emails leave no doubt that, overdraft revenue being a big profit center, the bank's dominant, indeed sole, motive was to maximize the number of overdrafts and squeeze as much as possible out of what it called its ‘ODRI customers’ (overdraft/returned item) and particularly out of the four percent of ODRI customers it recognized supplied a whopping 40 percent of its total overdraft and returned-item revenue.” The court found this internal history to be completely at odds with the bank’s public stance, which included the position that “overdrafts must be discouraged.” In fact, they were encouraged at every turn, despite the prescient warnings of an executive that (1) this was a bad thing to do to vulnerable consumers and (2) Wells Fargo was going to get sued over it.

Wells Fargo expected commingling to add $40 million to its bottom line annually in overdrafts, on top of what high-to-low already generated. This was the “only significant factor” behind the change. For California customers, the percentage of accounts incurring overdraft fees rose 7.8% after commingling was instituted, and the number of overdraft items per overdrafted account rose 10.1%.

Likewise, Wells Fargo expected the shadow line to generate an additional $40 million annually, over and above commingling and high-to-low, and that was the motivation for the change. This was because almost all debit card transactions are instantly approved or declined based on the money in the account, and settled (merchant gets payment from bank, bank takes money from account, all is right with the world) within a couple of days at most. Before the shadow line, any debit card purchase approved by the bank would therefore almost certainly avoid an overdraft fee. With the shadow line, “the bank had now found a way to rack up overdraft fees for point-of-sale purchases that previously were protected from overdrafts.” It’s theoretically possible that an intervening deposit might save the day in the interval between authorization and settlement, but that’s not the way to bet, and Wells Fargo didn’t. In fact, its expectations of $40 million in additional revenue were realized.

The bank was so concerned about maximizing overdraft revenue that when overdrafts dropped unexpectedly it commissioned an internal study, asking whether the manipulations in question were driving customers away. The study concluded that, fortunately for Wells Fargo, overdrafts had only dropped because of seasonal tax refunds that briefly swelled the accounts of frequent ODRI flyers, and that Wells Fargo could therefore expect the spigot to turn back on again. (The relevant emails were unredacted after a threatened Rule 37 motion.) Among other things, the emails showed that decisionmakers closely monitored overdraft fee revenue, and that they viewed any decline in overdrafts as “cause for concern” rather than for celebration (as was their public position). The return of the overdrafts would be “good news.” Moreover, Wells Fargo recognized that 4% of its customers generated 40% of its overdraft fee revenue, and that new accounts generated the bulk of overdraft revenue, and was afraid of driving them away.

A court order allowed plaintiff’s expert to access Wells Fargo’s data and crunch the numbers, revealing that the high-to-low switch increased overdraft fees by hundreds of millions of dollars for the California class during the class period. The court found that “gouging and profiteering were Wells Fargo's true motivations behind the high-to-low switch and the allied practices that soon followed.”

The court rejected Wells Fargo’s post-hoc rationalizations for the practices. First, Wells Fargo argued at trial that customers wanted and benefitted from high-to-low posting. The evidence for this was not credible. Because the vast majority of debit card purchases are “must pay” items—if authorized, the bank must pay them, even if the account balance is insufficient—posting them in high-to-low order confers no benefit on customers. Only two extremely rare exceptions allow the bank to reject debit card purchases: if the merchant didn’t obtain authorization before presenting the transaction for settlement, or if it didn’t present the transaction for settlement within 30 days. “Unlike checks or [automated] transactions, which the bank can return unpaid, there is no risk that Wells Fargo will reject a large debit-card purchase if it posts last rather than first.”

There was no evidence of any correlation between the dollar amount of an item and its priority of payment for the depositor, who might prefer to pay a small charge to the government than a larger private charge (as the court pointed out, a small check to pay a traffic ticket might go unpaid under the bank’s commingling scheme), and in any event the hypothetical “paying the mortgage” scenario was inapplicable to debit card purchases. But it was mathmatically certain that high-to-low increased overdrafts. The court “reject[ed] completely” the contention that consumers would prefer or benefit from “bone-crushing multiplication of additional overdraft penalties.” The numerous complaints filed by depositors, protesting how they’d been deceived by Wells Fargo, confirmed this.

Anyway, the bank produced no evidence that Wells Fargo management actually discussed or considered this supposed “benefit” for customers when it made its decisions. Nor did it produce even post-hoc studies or documentation that any Wells Fargo customers preferred high-to-low for any transactions, much less debit cards. Two Wells Fargo witnesses referred to a supposed 1998 consumer survey, which “proved to be an utter phantom.” The customer-focused rationale “was invented merely for public consumption and was not an actual motivating factor at the time any high-to-low decision was made, much less the high-to-low decision for must-pay items.” The only time it appeared was in “argument pieces distributed after the fact as scripts to bank employees to help justify the high-to-low posting order to customers who complained.”

The court further noted that only about a quarter of FDIC-supervised banks used high-to-low as of 2008, and that if it were true that consumers preferred this order one would expect that more banks would be doing it “and indeed promoting it as a plus.” Wells Fargo has never done so, and indeed “took pains to obfuscate this practice,” because it’s not a plus.

In deciding not to address high-to-low posting in 2009, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, and the National Credit Union Administration stated in the Federal Register that it would be difficult to set forth a bright-line rule that would clearly result in the best outcome for all or most consumers, repeating the mortgage payment scenario. But that was not a decision, merely a choice not to decide at that time. “At most, it merely said that low-to-high posting--the proposal on the table--was not invariably the best sequence, a truism, and that the agencies were not yet ready to decide one way or the other whether to impose it on all banks in all circumstances.”

More saliently, that statement couldn’t outweigh the extensive trial record, when Wells Fargo was given a full and fair opportunity to prove a consumer preference for or benefit from high-to-low: “This is not an administrative proceeding where any blurb and argument piece can be tossed into the bin. We have had a trial with evidence and safeguards for getting at the truth. It is now evident that the bank's supposed studies and rationales have withered and vanished under effective cross-examination.” (I’m actually cutting out a lot of the court’s outrage. This is not to indicate that I think the bank’s conduct was anything other than outrageous.)

As for commingling, Wells Fargo witnesses testified that a key motivation was to “migrate” consumers and merchants from one transaction type (checks) to others (debit card and automated). Posting such transactions separately had supposedly become “increasingly confusing” to customers and service personnel. This also allegedly allowed the bank to honor more high-dollar items in the form of checks and automated transactions.

However, there was no documentary evidence that Wells Fargo considered “migration trends” when it made its decision. Nor was there any documentary evidence that any customers or service personnel were “confused” by separate posting. To the contrary, the evidence was that customers weren’t even aware of how posting worked. Nor did the bank notify customers about the old system, the new system, or the change. And the court already rejected the “paying more high-dollar items” rationale. The amplification of the harm to consumers was exactly why one Wells Fargo executive recommended against commingling, as he’d recommended against high-to-low; as before, he was overruled, despite his warning about litigation. The testimony about customer preference/benefit, and Wells Fargo’s consideration of same, was not believable.

The same sad story applied to the shadow line extension. Wells Fargo claimed that a key motivation was to increase the approval rate for debit card purchases. But why? Because it would “promote” (the bank's term) overdrafts. Again, no documentary evidence showed customer benefit from or preference for the change. Customers weren’t warned about overdrafts in progress, and the court didn’t believe they’d prefer this system, which explains why the Federal Reserve recently banned the practice absent affirmative opt-in.

The bank then asserted a preemption defense. The relevant regulation, 12 C.F.R. 7.4002, states:

A national bank establishes non-interest charges and fees in accordance with safe and sound banking principles if the bank employs a decision-making process through which it considers the following factors, among others:

(i) The cost incurred by the bank in providing the service;

(ii) The deterrence of misuse by customers of banking services;

(iii) The enhancement of the competitive position of the bank in accordance with the bank's business plan and marketing strategy; and

(iv) The maintenance of the safety and soundness of the institution.

Several problems: (1) Wells Fargo didn’t actually consider any of these factors when implementing the challenged practices; testimony that high-to-low posting was justified in part by cost considerations was not credible, and there was no documentary evidence supporting it. It’s true that switching to high-to-low in California brought California in line with the rest of the bank, but that doesn’t say anything about why the rest of the bank switched, which on the record was not motivated by cost considerations. Uniformity might have been good, but the bank chose high-to-low not because that minimized its costs but because that maximized its revenue. Likewise, there was no evidence that the bank instituted high-to-low to deter customers from misusing banking services. To the contrary, high-to-low with commingling and the shadow line was designed to, and did, significantly promote overdrafts. The court rejected testimony about Wells Fargo’s hopes for deterrence as untrue. There was also no consideration of the bank’s competitive position. Testimony to the contrary was “unanchored in a specific recollection” and simply recited what the bank “would have” considered, conveniently “regurgitating” the factors listed in the regulation. When asked directly, the bank’s witness couldn’t recall whether Wells Fargo considered competitors’ practices at all, and as was the pattern there was no supporting documentary evidence.

(2) Finally, no documentary evidence supported Wells Fargo’s argument that it made the change to maintain safety and soundness. Increasing profits could arguably contribute to safety and soundness, no matter how those profits were obtained from consumers. But the court found it implausible that promoting overdrafts served the goal of safety and soundness, and doubted that bank regulators would agree with Wells Fargo.

(3) If these policies had been “non-interest charges and fees” (which they weren’t, because they were policies for producing separately established non-interest charges and fees, a state law issue) covered by this regulation, Wells Fargo would have had to keep records to prove compliance for bank examiners to review, which it did not do.

Given the 9- to 12-month planning process required to deploy these practices, “there should have been some documents or emails showing that the bank considered these factors,” but there weren’t. “While Wells Fargo asserted that it did not have document retention policies at the time for these types of documents, its retention policies were never offered at trial despite an express invitation to present them at trial.”

In any event, the OCC (the relevant regulator) has specifically stated that a breach of good faith under California law could justify applying state law without triggering preemption if a bank misrepresents its policies to consumers. Wells Fargo also argued that a couple of other sections of the CFR applied; the court found that they were equally inapposite (protecting Wells Fargo’s “deposit-taking” powers against state regulation, for example, doesn’t require allowing Wells Fargo to reorder transactions solely for its own benefit).

The court then turned to a settlement release in a class action, Sean M. Smith v. Wells Fargo Bank, N.A. (Case No. GIC802664, San Diego Sup. Ct.), over an alleged failure by the bank to adequately disclose the extension of the shadow line to debit-card purchases in a 2002 "Policy Change Notice." A settlement was approved in November 2007. Class members were allowed to submit a claim form stating that they’d incurred an overdraft fee during the 12-month period following May 24, 2002, and Wells Fargo would then refund up to $20, subject to an aggregate cap of $3 million. “What Judge Prager did not know--since it only came to light in this proceeding--was that Wells Fargo paid merely $2080 to 166 claimants. This is not a typo.” Class counsel, however, received $2.2 million—a fact Wells Fargo only disclosed after repeated requests from the court here. The court concluded that the settlement was “almost certainly collusive,” though that was not determinative of any aspect of the present litigation.

Judge Prager later ruled that, though the named plaintiff here was a member of the settlement class, the claims in this case were not released by the Smith settlement. Though its language appeared broad, the release was actually limited to the claims in the Smith complaint, specifically flawed disclosures in a 2002 policy change notice. Judge Prager made this ruling without knowledge that Wells Fargo had only paid out $2080 to claimants.

The court then turned to Wells Fargo’s misleading materials and inadequate disclosures. “Given the harsh impact of the bank's high-to-low practices, the bank was obligated to plainly warn depositors beforehand. Instead, the bank went to lengths to hide these practices while promulgating a facade of phony disclosure.” The court found that Wells Fargo’s marketing materials deceived reasonable consumers to expect that purchases would be debited in the order made, rather than resequenced high-to-low. The fine-print statements that Wells Fargo could pay items in whatever order it chose were insufficient, especially since Wells Fargo had emphatically decided to pay in high-to-low order, and never gave notice of the change. Later on, it added specific reference to high-to-low order as a possibility in the fine print. But the revised language kept using “may,” language, compounding the deception by reinforcing the impression that Wells Fargo had not yet chosen high-to-low. In any event, the disclosure “was buried within a sea of single-spaced text stretching over 60 pages in tiny ten-point font,” usually in the middle of the document. “[N]o reasonable depositor could be expected to read the entire document or locate the ‘disclosure’ …. Moreover, even if the customer read the [document], no reasonable depositor could be expected to understand the disclosure regarding posting order and overdraft fees, especially given the deceptive use of "may" throughout the disclosure.”

Wells Fargo’s own consumer expert, Itamar Simonson, to his credit, testified that it was “completely unrealistic to assume that ... many consumers would actually read those lengthy documents” and that the length and complexity of the agreement made it “so difficult for consumers to understand.” He further testified that “it would be impossible for [customers] to predict the exact balance [of their checking accounts] at any particular point in time” even if they read the agreements, which everyone agreed they probably didn’t. As Simonson noted, those Wells Fargo customers who do read the agreement “are probably not the same people who just have $20 in their bank account, and playing it close to the edge.” I would be shocked if anybody but the lawyers drafting the agreement actually read it. I’ve read that Elizabeth Warren assigns law students their own credit card agreements, and that most can’t make heads or tails of significant portions thereof; I believe it.

The court pointed out that Wells Fargo knew how to speak plainly after the fact, “when a customer complained about getting hammered with overdraft fees.” At that point, Wells Fargo provided a clear explanation of its posting process:

… The decision to pay or return items is based on the number of overdraft occurrences in the preceding 12 months.

We pay items from highest-to-lowest dollar amount. Transactions are processed in the following order:

• Credits

• Fees from overdraft/or returned items of the previous day

• Previous day's work--Items with an as of date

• Cash withdrawals

• Checks, check card and POS purchases from highest-to-lowest to [sic] dollar amounts

Wells Fargo had the same clarity in its phone scripts. “The very existence of these clear after-the-fact explanations further highlights the bank's before-the-fact obfuscation.”

No other documents alerted depositors to the multiplication effect of high-to-low; it wasn’t, for example, disclosed on the bank’s fee schedule (which, not for nothing, it would have to have been if it had been a pricing decision as claimed by Wells Fargo in its preemption argument). “Throughout the class period, Wells Fargo separated credit transactions, debit-card transactions, and checks on its printed account statements. The separation of these transactions made it nearly impossible for a customer to determine the actual posting order being employed by the bank.”

In fact, the “murky disclosures” were “exacerbated by misleading information widely disseminated by Wells Fargo reinforcing the perception that transactions would be deducted from their accounts in chronological order.” Wells Fargo persistently used the theme that debit card purchases were “immediately” or “automatically” deducted from an account, leading the class to believe “(1) that the funds would be deducted from their checking accounts in the order transacted, and (2) that the purchase would not be approved if they lacked sufficient available funds to cover the transaction.” Typical statements: “Don't spend money today counting on a deposit tomorrow. Check card and ATM transactions generally reduce the balance in your account immediately” and “Remember that whenever you use your debit card, the money is immediately withdrawn from your checking account. If you don't have enough money in your account to cover the withdrawal, your purchase won't be approved.”

If customers went online, Wells Fargo displayed “pending” debit card purchases in chronological order, leading them to believe that processing would take place in that order, even though they were never posted in that order during the class period, as the bank well knew. The website didn’t warn them that pending transactions would be resequenced behind the scenes. Instead, Wells Fargo encouraged customers to keep track of their balances using a register, which fostered the false view that items were deducted in chronological order.

A customer faithfully using a register would know the exact transaction at which her account went into overdraft. “That faithful customer could not reasonably be expected to know that the bank would manipulate the order of her transactions so as to deplete her account balance faster than shown in her register, triggering not one but as many as ten overdraft penalties, all due to the bank's high-to-low bookkeeping scheme. A precise register could never alert a customer who makes a mistake that her one overdraft will be converted into as many as ten overdrafts.”

Similar inadequate disclosures attended the shadow line, whose specific workings “remain shrouded in secrecy.” It’s some sort of “computerized credit-risk assessment on an account-by-account basis” designed to promote overdrafts at the point of sale (the shadow line was also known as “overdraft via POS,” in the bank’s internal memos, indicating its true and sole purpose). “The available-balance information communicated online to customers was supposed to represent the amount of funds the bank would make available for their next transaction. Wells Fargo defined it as such. This, however, was not true. Wells Fargo allowed customers to spend more than their available balance using their debit cards via undisclosed shadow-line overdrafts.”

Before adopting the shadow line for debit card purchases, Wells Fargo added a notice to account statements and new account agreements indicating that, if an account had insufficient funds, it could choose to decline the transaction, or could choose to pay the item and charge an overdraft fee for a debit card purchase. (This notice was the subject of Smith, which involved whether the notice adequately disclosed the shadow line itself; the present case involves the high-to-low practice, and the disclosure is only relevant here because it didn’t adequately disclose the impact that high-to-low would have on overdraft fees.) The court found this notice inadequate to constitute fair warning. First, at all times, all banks have the option under commercial law to pay an item into overdraft or to decline to do so. The real change was a switch from routine denial to routine approval without point-of-sale notice. Second, the notice warned that the customer “may” be charged a fee, but the conditional language was misleading, as was the implication that there’d be “a fee” instead of possibly ten fees, at $35 each. In short, the insert vastly understated the risks that the shadow line would amplify the impact of high-to-low, which was likely to deceive class members.

The record also included hundreds of customer complaints expressing indignation that transactions were "re-dated," "re-arranged," and "manipulated" from the order in which they had occurred. (These were admissible to show that “depositors were assessed large overdrafts and that customers--once informed of the bank's rationale--disagreed that high-to-low resequencing was for the depositor's benefit.”) The court agreed that “Wells Fargo constructed a trap--a trap that would escalate a single overdraft into as many as ten through the gimmick of processing in descending order. It then exploited that trap with a vengeance, racking up hundreds of millions off the backs of the working poor, students, and others without the luxury of ample account balances.”

The court then turned to Wells Fargo’s ability to engage in the business of banking. Federal law doesn’t preempt general laws banning deception by all businesses. The court found that enforcing plaintiffs’ claims would only have an incidental effect, and would not “obstruct, impair, or condition” the bank’s ability to exercise its deposit-taking powers. For years, Wells Fargo used low-to-high and other posting methods. And it’s complied with far more restrictive laws in Nevada barring high-to-low simply by posting transactions differently in Nevada; it also posts them differently in New Mexico and Washington. Thus, there was no conflict or other preemption.

Conclusions of law: these practices were both unfair and fraudulent under Section 17200. Unfairness requires plaintiffs to (1) identify an unfair policy or practice tethered to a legislatively declared policy or (2) show an actual or threatened impact on competition. Here, the unfairness claim was properly tethered to the legislative comment to California Commercial Code Section 4303(b), which addresses the relationship between the bank and presenters of items for payment. The code generally gives banks discretion to pay items in any order, subject to a legislative comment that “[t]he only restraint on the discretion given to the payor bank … is that the bank act in good faith. For example, the bank could not properly follow an established practice of maximizing the number of returned checks for the sole purpose of increasing the amount of returned check fees charged to the customer.” The comment also made clear that the bank’s discretion was item-by-item, allowing the bank to prioritize a check to the IRS, or another check, if it "appears to be particularly important."

The court ruled that computer-driven resequencing isn’t the exercise of item-by-item discretion, which fed into the court’s conclusion that the posting discretion afforded by California law “must be exercised in good faith towards the customer and may not be exercised solely to drive up overdraft fees.” “Wells Fargo itself argued that Section 4303(b) applied to both checks and debit cards when it raised this section as a shield to liability--albeit without expecting anyone to read the legislative comment.” The court also pointed out that relying on California law was in tension with the preemption argument.

Even without the California version of the UCC, there is an implied covenant of good faith and fair dealing in the exercise of its contractual discretion that the bank breached. Express grants of discretion are subject to the reasonable expectations of the parties, which were violated here. The public interest is also important in determining the parties’ reasonable expectations in the context of adhesion contracts. The legislative comment to §4303(b) evidences California policy to ensure that banks act in good faith when reordering transactions and not attempt to ramp up overdraft fees. Given the ambiguous at best language in the contract on posting order, even a sophisticated customer could reasonably have believed that Wells Fargo hadn’t yet chosen high-to-low or would implement it on an item-by-item basis. Ambiguities are resolved against the drafter. Moreover, the contract stated that posting order would be subject to laws requiring or prohibiting a particular order, meaning that Wells Fargo subjected itself to the good faith limitations of California law.

Consumers reasonably expect overdraft fees, but not what happened here: consequences so severe and pernicious that they should be allowed, if at all, only by showing that they were reasonably expected by the parties. “Here, the proof is the opposite. The bank went to great lengths to bury the words deep in a lengthy fine-print document and the words selected were too vague to warn depositors, as even the bank's own expert conceded.”

Wells Fargo acted in bad faith, motivated solely by avarice, in posting debit card transactions high-to-low, commingling debit card transactions with others, and using the shadow line to increase overdrafts, thus making its conduct unfair. Wells Fargo argued that it wasn’t seeking to maximize overdraft fees, because it posted credits to accounts before debits, offered overdraft protection services, limited overdrafts to ten a day, and eventually put a one-dollar “courtesy threshold” in place before assessing overdraft fees. “That Wells Fargo could have gouged even worse than it has hardly alters the fact that it has gouged badly. Plaintiffs do not need to prove that the bank mistreated depositors in every way possible in order to show that they were mistreated.” The challenged practices were implemented for the sole purpose of multiplying overdrafts. Overdraft protection, which is another profit center for the bank, didn’t change the intent of high-to-low to squeeze more overdrafts out of consumers.

Wells Fargo also blamed consumers: if they’d simply avoided overdrafting their accounts, they’d have avoided the fees, and thus Wells Fargo’s conduct couldn’t be unfair. The court disagreed. Of course “we should all live within our means,” and of course “when we overdraft, whether by accident or not, we must expect to pay a fee.…This, however, cannot justify turning what would ordinarily be one overdraft into as many as ten.”

Likewise, Wells Fargo’s conduct was fraudulent in that reasonable consumers were likely to be deceived by poor disclosure and misleading promotions focusing on chronological accounting. (The court noted that it’s fine to promote the use of check registers—but wrong to lead customers to expect that items will be deducted in chronological order if they won’t be.) If Wells Fargo was going to gouge consumers like this, it should have prominently disclosed its high-to-low scheme and its effects. It didn’t.

The court declined to order relief on the negligent misrepresentation and fraud claims, since the Section 17200 claims were established; false advertising under Section 17500 also followed from the finding of fraudulent conduct.

Under Prop. 64, plaintiffs must prove actual reliance to have standing to bring fraud-based Section 17200 claims on behalf of absent class members. Under the Tobacco II cases, the class plaintiffs here did so by proving that deceptions were “an immediate cause” of their injury; they didn’t need to show that deception was the sole or even the predominant or decisive factor, as long as the representation at issue played a substantial part in influencing their decisions. Additionally, where a plaintiff has been exposed to "an extensive and long-term advertising campaign," proof of individualized reliance on specific misrepresentations or false statements is not required. Gutierrez and Walker clearly met these standards.

The court further rejected Wells Fargo’s argument that the classwide misrepresentation claims had to be “surgically and precisely limited” to those identical to the class plaintiff’s, including the exact documents at issue. Tobacco II: “Representative parties who have a direct and substantial interest have standing; the question whether they may be allowed to present claims on behalf of others who have similar, but not identical, interests depends not on standing, but on an assessment of typicality and adequacy of representation.”

The relief granted was limited to high-to-low resequencing. The Federal Reserve dealt with the shadow line by requiring opt-in and mandating disclosure of the downsides of opt-in (though banks are already trying to figure out how to convince consumers to do so anyway). This regulation was instructive to the court’s order of injunctive relief. As of November 30, Wells Fargo was ordered to cease high-to-low posting for debit card transactions for class members, either using low-to-high or chronological posting, or some combination.

In addition, the court ordered restititution for wrongful extraction of overdraft fees. In order to prevent wrongdoers from benefiting from their misconduct, relief under the UCL is available without individualized proof of deception, reliance, or injury if necessary to prevent the use of an unfair practice. Thus, absent class members need not show on an individualized basis that they’ve lost money or property as a result of the unfair practice. That said, restitution must be restitution: the return of money obtained through an unfair business practice to those persons from whom the money was taken.

The court concluded that chronological posting was the best way to measure the appropriate restitution, rather than low-to-high. Low-to-high is more favorable to depositors, and was the prior system, but the plaintiffs’ case had as a theme that the bank promoted an expectation of chronological posting. Plaintiffs’ expert showed that it was entirely practical to re-run the stored data for each class member’s account to determine how many overdrafts were added by high-to-low. In fact, he did so (after receiving the data pursuant to court order).

The court set forth the proper sequence for calculating restitution, posting credits and priority debit transactions (cash withdrawals and equivalents), then debit card transactions in chronological order (and after that low-to-high where there was no date/time information), and finally checks and automated transactions high-to-low. This preserved the usual and customary order of everything else while fixing the debit card transactions, as opposed to commingling or putting checks and automatic transactions first. The court described Wells Fargo’s proposal as “radical rearrangements and manipulations of credits, checks, and [automatic] transactions … to artificially minimize the restitution awarded to the class.”

The court also specifically noted that a small percentage of debit card transactions (16%) lacked date/time information, but “it makes very little difference in the aggregate whether these transactions without date/time information are posted before or after the chronologically sequenced debit-card transactions that did have date/time information,” a conclusion with which the bank’s own expert agreed. Moreover, data deficiencies in the computer systems used to power the bank’s unlawful practices shouldn’t be used to avoid restitution. “It would not be equitable to allow the bank to extract hundreds of millions of dollars through unfair and fraudulent business practices and then use the supposed inadequacies of its own record-keeping system to shield itself from restitution.”

This calculation excluded overdraft fees that would have been assessed regardless of sequencing, such as overdraft fees solely attributable to the shadow line, as well as overdraft fees the bank never managed to collect, class opt-outs, and overdraft fee reversals. The result was close to $203 million.

Wells Fargo argued that plaintiffs’ studies failed to take the shadow line into account. The court found this a red herring. First, plaintiffs were never provided with the proper tools to investigate the shadow line. “Instead, they were provided with a bare algorithm--without any accompanying instructions--that would take years to decipher and many guesses along the way.” The bank’s own restitution expert couldn’t program the shadow line from scratch, instead using Wells Fargo’s preprogrammed system for his forensic calculations, “a luxury denied to plaintiffs' expert.” Second, all of the bank's analyses were based on 10 days’ worth of customer data (as compared to the 43 months of data analyzed by plaintiffs). “This strips the bank's arguments of all weight and credibility.”

Wells Fargo is, of course, appealing. And the peasants are revolting.

Tuesday, August 24, 2010

Cherry-picking wood leads to affirmed injunction

Osmose, Inc. v. Viance, LLC, --- F.3d ----, 2010 WL 2977988 (11th Cir.)

Viance issued press releases expressing serious safety concerns about wood treated with Osmose’s copper-based wood preservative, MCQ. Osmose sued for false advertising, arguing that Viance’s studies didn’t support the broad safety claims in the ads. Viance counterclaimed for false statements about MCQ. The district court granted Osmose’s motion for a preliminary injunction and denied Viance’s motion; Viance appealed only the injunction entered against it. The court of appeals affirmed in part and remanded to modify the injunction in light of First Amendment concerns.

The parties compete in the wood preservative market. Viance sells ACQ, which has copper solubilized in an alkaline solution. It was the dominant product in the early part of the decade, and at that time, Osmose licensed the technology from Viance. Osmose then developed a competing product using micronized copper suspended in solution, MCQ. “Osmose has obtained certification from the ICC Evaluation Service--an association that issues evaluation reports for building products and material to determine whether they comply with model building codes--for its MCQ product, but MCQ has not been certified by the America Wood Protection Association (AWPA). Viance's ACQ is approved by both organizations.” MCQ began to draw market share from ACQ, and Viance began to test it.

Viance believed that the copper in MCQ didn’t penetrate wood in sufficient quantities tp protect against microorganisms that produce soft rot. It used scanning electron microscope (SEM) testing to show lower copper concentration in the cell walls of MCQ-treated wood, though the Viance employee who performed the testing concluded that the long term performance implications of this finding were unknown. Viance also engaged in field stake testing, an accepted method of testing wood preservatives’ effectiveness. A wood scientist at Mississippi State University concluded that the MCQ stakes were performing poorly, but recommended additional data. Viance then hired a PI to search central Florida for in-use MCQ-treated posts. The firm visited 18 sites and interviewed numerous retailers and builders, none of whom had experienced or heard of any problems with premature decay in MCQ-treated products.

Viance continued to search, and discovered posts allegedly showing premature decay in Baton Rouge, Louisiana. Viance hired Timber Products Inspection, Inc., an independent company that inspects and tests wood products, to test eleven posts it chose from the Baton Rouge site. Timber Products rated the posts as 9 or 9.5 on a 10 point AWPA scale of soundness in which 10 represents sound wood and 0 represents total failure, noting that its report shouldn’t be considered acceptance or rejection. Viance also had 45 posts from Alpharetta, Georgia tested. On visual inspection, twenty-six posts rated a 10, eleven rated a 9.5, five rated a 9, two rated an 8, and one rated a 7. Of the fourteen posts subjected to further examination, four posts rated a 10, five posts rated a 9.5, two posts rated a 9, two posts rated an 8, and one post rated a 7. Over the course of its search, Viance inspected roughly 530 MCQ-treated posts.

Viance then issued two press releases titled: "Decaying 4x4 Posts Confirm Performance Concerns with Micronized Copper Wood Preservatives" and "Hidden Danger in Your Backyard." Statements included: "Findings on 4x4 posts at residential locations reveal dramatic evidence that wood treated with micronized copper preservative (MCQTM) is decaying more rapidly than anticipated." Safety-related statements included: “The decay, verified by Timber Products Inspection (TPI), is considered unacceptable for providing long-term structural integrity for residential and commercial uses" and " ... the severity of the decay on these micronized copper-treated posts raises alarming consumer safety concerns about structures built using micronized copper treated wood." Viance also sent an email with the subject line "Is a Treated Wood Lawsuit in Your Future?" containing the statement: "the safety of your customers and clients is at stake if your projects' support structures are being built with Micronized treated wood that cannot adequately resist decay."

Osmose responded with a press release criticizing Viance’s studies. Timber Products also issued a press release clarifying its role and the limitations of its report, rather pointedly noting, among other things, that Viance didn’t give it a random sample to test and that its report shouldn’t be used to make unsupported generalizations. Osmose then sued.

After a hearing, the district court issued an injunction that, among other things, allowed Viance to publish the results of its studies/tests, but barred it from claiming or implying that those studies demonstrate that structures using MCQ-treated wood are unsafe, pose a threat to consumers, or are structurally unsound, or that micronized copper preservatives are defective or less effective than solubalized copper preservatives. Viance was not allowed to draw its own conclusions about what the studies indicate and attribute those conclusions to the studies unless the data clearly supported those conclusions: any conclusions attributed to the studies had to be stated by the studies themselves or readily apparent from the data. Viance could not indicate or imply that conclusions or opinions were verified or endorsed by Timber Products.

The court of appeals reviewed the literal falsity ruling for clear error and upheld it. These were “tests prove” or establishment claims, as indicated by Viance’s repeated use of the term “findings.” The burden of proof on Osmose was to demonstrate that the tests didn’t support the conclusions Viance drew from them.

Viance argued that its statements were truthful fact (the findings show premature decay) combined with non-actionable opinion (this raises safety concerns). The court of appeals disagreed. Even in isolation, these purported opinions might be reasonably interpreted as more than opinion. “Representations that the use of a particular product ‘poses a considerable safety hazard’ because of a risk of failure or that structures built with micronized copper-treated wood might be at risk ‘because the wood may be subject to early failure and possible collapse’ arguably are reasonably interpreted as more than subjective statements regarding the efficacy or superiority of a product. Instead, they can be viewed as expressing an objective risk of serious consequences that fairly implies a basis for that statement.” These claims arguably could be judged true or false based on empirical testing, as Viance in fact attempted.

The court of appeals didn’t decide the issue, though, because the context in which the statements appeared made it clear that these were unambiguous establishment claims, not mere opinion. They were generally made in the same sentence as a reference to Viance’s “findings,” which referred to the Timber Products reports. And some statements weren’t even fairly subject to Viance’s parsing, such as “the severity of the decay on these micronized copper-treated posts raises alarming consumer safety concerns about structures built using micronized copper treated wood” and “[o]ur findings show that micronized copper-treated wood will lead to problems with structural integrity.” These were straight-up establishment claims.

Likewise, the court of appeals upheld the finding that these claims were literally false because Viance’s broad conclusions weren’t adequately supported by the tests. First, Viance never inspected structures built with MCQ-treated wood, only fence posts, lot markers, and stakes. Second, “Viance had to go to considerable trouble to find any posts showing decay in its in-service survey, and ultimately only found that thirteen of the 530 MCQ-treated posts it inspected were rated a 9.0 or lower.” Such a low percentage did not support broad generalizations about the integrity or safety of structures built with MCQ-treated wood. Third, the reports were specifically qualified as not supporting any conclusion about physical quality and performance.

Viance argued that field stake testing is a standard industry measure used to test wood preservatives and that the posts tested were the same type used to build structures. Because the key issue in testing wood is contact with the ground, it argued, conclusions about structures were justified. The court of appeals was uncertain of the district court’s first rationale. If the district court meant that the particular tests performed didn’t purport to indicate that the level of decay revealed indicated structural weakness or safety concerns, that was not clearly erroneous. Viance’s tests didn’t assess the affect of the decay on the structural integrity of the wood, though such a test was available.

Turning next to the percentage of posts affected, Viance argued that the district court erred in calculating the percentage, because it didn’t have all 530 MCQ-treated posts analyzed. It calculated that of 56 posts analyzed, 30 rated 9.5 or lower, or 54% showed some decay, which was large enough to support serious safety concerns. There were four parts to the district court’s reasoning: the threshold rating at which a post should be counted as having significant decay, the number of posts decayed under that standard, the number of posts comprising the total sample, and whether the resulting percentage of decayed posts supports a conclusion of serious safety concerns. Viance didn’t support its contention that anything less than a perfect ten meant decay indicative of serious safety concerns. Using 9.0 as the threshold rating wasn’t clearly erroneous, given that the rating system is subjective and that there was testimony that a rating under 10 was not necessarily less than sound.

Despite a potentially incorrect calculation of the number of posts with a 9.0 rating or lower, the counting error was not significant. The district court didn’t clearly err in taking 530 as the sample size, given that Viance spent substantial time and resources to find decaying MCQ-treated posts without much luck. On the record, “the district court was certainly not obligated to use the fifty-six posts that Viance specifically identified as showing sufficient signs of decay to warrant further testing as the total sample size for the survey.” Viance argued that some of the 530 posts it examined were encased in concrete or otherwise not amenable to further testing, but produced no evidence about the percentage of inaccessible posts. Thus, even using a higher number of decayed posts, the percentage decayed was only 18/530 or 3.4%.

The key link in the causal chain is whether this percentage (or 2.45% as the district court calculated) supports the conclusions in Viance’s ads. A professor of wood science and technology at Michigan State testified that his study of MCQ showed that 2.9% of posts had “issues,” which made him conclude that MCQ was a “robust, very good wood preservative.” As a result, the district court didn’t clearly err in concluding that the percentage was too low to support the safety concerns in the ads.

Finally, Viance argued that the district court shouldn’t have relied on qualifying language in the Timber Products reports and its own employee’s report on field tests, especially since the VP of Timber Products testified that he had no problem with Viance drawing conclusions about micronized copper based on the reports. The court of appeals disagreed. The qualifications “undermine[d] the breadth of the conclusions that Viance seeks to draw.”

The district court also found that Viance’s statements asserted that Timber Products shared Viance’s concerns: "The decay, verified by Timber Products Inspection (TP), is considered unacceptable for providing long-term structural integrity for residential and commercial uses." Viance argued that this was literally true: Timber Products verified the decay, and Viance then drew the conclusion. The court of appeals noted that the literal falsity/implicit falsity line is not always clear, and a district court’s findings will be upheld if not clearly erroneous. There was no clear error here. The ads relied “heavily and repeatedly” on the independence and reputation of Timber Products, and several times unambigously stated that Timber Product’s findings raised serious concerns. Nor did the district court clearly err in finding literal falsity: Timber Products stated that its reports shouldn’t be considered as acceptance or rejection of the physical quality of the wood. According to a witness from Timber Products, “[it] cannot conclude and has not concluded that micronized copper treated wood treating systems, including MCQ, are not as effective and reliable as any other major wood preservative treating system." Moreover, had Timber Products been aware of Viance’s intended use of its reports, it wouldn’t have performed the tests for Viance.

Viance challenged the materiality of the Timber Products statements. The court of appeals found materiality “self-evident,” because the statements served as verification and endorsement of the concededly material safety and efficacy claims. “[T]he heavy reliance on Timber Product's independence and reputation enhances the likelihood that misrepresentation would influence purchasing decisions.”

Viance also argued that the district court erred on the other preliminary injunction factors. The district court found a likelihood of irreparable harm without applying any presumption, even though literally false comparative statements have often been presumed irreparably harmful, because of uncertainty over the effect of eBay. On their face, the statements would likely cause irreparable harm because they represented serious indictments of the safety of Osmose’s products that would likely be remembered by consumers. Also, Viance’s stated goal was to put Osmose out of business. The court of appeals declined to decide whether eBay ended the presumption of irreparable injury, because the district court didn’t abuse its discretion in any event. The inference of harm to Osmose’s goodwill and market position was reasonable, given the seriousness of the claims.

Viance argued that harm was unlikely because the intended audience of the advertisements was industry professionals. Given that one release was titled "Hidden Danger in Your Backyard," the court of appeals concluded that the target audience for the advertisements was not solely industry professionals. Moreover, the ads could also reasonably affect the decisions of companies that supply lumber to consumers. Although pressure treated wood producers issued a letter and press release urging Viance to drop its campaign, that did not, as Viance contended, demonstrate that the target audience wasn’t confused or influenced by the ads. “The fact that certain industry members saw through these ads does not indicate that the purchasing decisions of sellers of pressure treated lumber or ultimate purchasers of pressure treated lumber would not be negatively influenced by these ads.”

The district court found the balance of harms weighed in favor of the injunction. The court of appeals found no abuse of discretion. Given the scope of the injunction, any harm to Viance is limited. Viance can participate in the scientific debate, because it can still publish the results of its testing and conclusions stated in the studies or readily apparent from the data. The injunction was not likely to shift market perception against Viance, as Viance argued; stopping the ads wouldn’t disparage Viance’s product or inappropriately bolster Osmose’s.

The district court further found that the public interest favored an injunction because consumer confusion or deception harms the public. Viance argued that “the free flow of commercial and non-commercial speech on topics of consumer safety” favors the public interest, but enjoining only unsupported statements doesn’t hinder that free flow.

The court of appeals agreed, however, that the district court abused its discretion by enjoining certain statements about Osmose’s certification, because it neither identified nor analyzed any Viance ads to that effect. Viance had sought a preliminary injunction about Osmose’s own statements about certification, claiming a false implication that the technology was EPA-certified. The district court held that Viance failed to demonstrate literal falsity or misleadingness. However, it never linked this finding to its decision to enjoin Viance from claiming that Osmose was not properly certified (I’m leaving out some details of what counts as “properly”). This portion of the injunction was vacated, though the court of appeals specifically noted that, if Viance had made such statements (presumably in commercial advertising or promotion) the district court could revisit the issue.

Finally, Viance argued that the injunction was an unconstitutional prior restraint because by its terms it could apply to protected noncommercial speech: petitioning the government, publishing scientific papers, arguing before certification organizations, or even giving testimony in this litigation. The court agreed and remanded for the injunction to be limited to statements made in commercial advertising and promotion. Osmose disavowed any intent to apply the injunction to protected noncommercial speech, and it hasn’t been enforced outside of advertising and promotional statements, but the literal terms bar such claims in any setting. A narrower injunction would protect Osmose’s goodwill and market position.

Comment: It's interesting that this is a case about press releases, given the court's First Amendment solicitude; the court takes as a given that press releases are commercial advertising or promotion--which I think is right, but might give at least some of the Justices who wrote in Nike v. Kasky fits.