Thursday, July 31, 2014

Second Circuit reiterates presumptions of harm, damages in literal falsity case

Merck Eprova AG v. Gnosis S.p.A., No. 124218 (2d Cir. July 29, 2014) 

Merck won a false advertising case against Gnosis, and the court awarded it over $500,000 in damages, over $2 million in attorneys’ fees and costs, and prejudgment interest, and also ordered corrective advertising.  The court of appeals affirmed in full.  The key holdings are both clear and relatively narrow: in a two-player market, literal falsity and deliberate deception justify legal presumptions of both consumer confusion and injury for liability purposes.  Willful deception also justifies an award of defendant’s profits, and enhanced damages in circumstances such as those present here.

The parties produce folate, a critical prenatal supplement.  The predominant naturally occurring form is known as 5MTHF.  Chemical compounds that differ only in their arrangement around a carbon atom, as are relevant here, are known as stereoisomers (either L and D or S and R).  In folate, L is the naturally occurring isomer; synthetically produced folate will have both and would thus be labeled “D,L” or “R,S.”  Merck was the first to manufacture a pure S isomer (aka L5MTHF), which it sold under the name Metafolin to customers who use it in vitamins and supplements.  This was an important and expensive-to-develop product for Merck.

Gnosis also makes raw dietary ingredients, and sold a product called Extrafolate (the current version of which was not at issue here).  Extrafolate was a mixture of the S and R isomer, also known as a “D,L5MTHF product.  This mixture doesn’t occur in nature and hasn’t been found to have the same nutritional benefits as L5MTHF.  As a mixture, it sells for significantly less than Metafolin—on the order of $10,000 less per kilogram.  But from 2006-2009, Gnosis used product specification sheets, brochures and other marketing materials that used the chemical descriptions, terms, and formulas attributed to the pure S-isomer for the sale of the R,S mixture.  Merck sued Gnosis in 2007.

In a bench trial, the district court found that Gnosis recognized that the mixture and the S-isomer had different chemical names, but deliberately used the S-isomer’s common name or abbreviation, and described the chemical properties of the pure product in its promotional material.  Gnosis continued this advertising until nearly two years after the litigation began.  The district court found that the use of the S-isomer’s common name and abbreviation was literally false, and that the use of descriptions of the chemical properties of the S-isomer in brochures, material safety data sheets, and certificates of analysis was literally true but implicitly, and intentionally, false.

“In essence, Gnosis was accurately describing a product it was not selling.”  Its statements were literally true in that they described the chemical makeup of a pure S-isomer product, but they were implicitly false because they were used in marketing a mixed product.  Comment: Hunh?  Literal falsity isn’t limited to claims that aren’t true of anything.  If I truthfully describe something that exists in the world, but I don’t have it to sell, selling something with that description isn’t literally true.  It’s literally false.  At the very least, the necessary implication of what Gnosis did was a literal falsehood.  No linguistically competent speaker of English would understand the materials as anything other than a representation that the product being sold was the pure S-isomer.  But because the literal/implicit falsity line has colonized other aspects of the doctrine, as we’ll see, this holding takes on exaggerated importance.

The district court found that Gnosis engaged in a “concerted and organized campaign to deceive customers.” Gnosis’s own expert testified that the pure isomer name is never used to refer to anything but the S-isomer.  Privately and in its patent application, Gnosis used the correct nomenclature.  The district court found Gnosis’s explanation for the labeling “simply fanciful—and false—and discount[ed] it entirely.”  Gnosis’s witness had testified that he’d read “two or three” articles that referred to the mixture substance as L5MTHF, but he could not recall the names of the articles.  The next trial day, Gnosis’s counsel informed the court that he’d reviewed the relevant documents, and that [t]hey do not . . .  exactly have the L5MTHF. The court concluded that “Gnosis’s use of the common name and abbreviation in its marketing efforts was a calculated decision to copy Merck’s advertising and capture a portion of Merck’s market share, knowing full well that its 6R,S Mixture Product was materially distinguishable from Merck’s pure 6S Isomer Product.”

On appeal, Gnosis challenged the district court’s presumption of consumer confusion and injury.  But under Second Circuit doctrine, a literally false claim may be enjoined without further evidence of impact on consumers.  And even in implied falsity cases, where a plaintiff shows intentional deception and egregious conduct, a presumption of deception arises.  Given the unchallenged factual findings of literal falsity and intentional deception as to the implicit falsity, a presumption of confusion was justified.  The intention to mislead was clear: “Gnosis put a description of the chemical properties of the Pure Isomer 6S product on its Extrafolate materials in order to mislead consumers into believing that they were, in fact, purchasing a Pure Isomer 6S product rather than the 6R,S Mixture Product, Extrafolate.”  (Query why such a presumption of confusion wouldn’t also be justified if a middleman was unaware that its supplier had deceived it.  The labeling and promotional materials would the same: a mixed product misidentified as pure.  At the very least, wouldn’t you want to call that literally false?)

When a plaintiff shows deceptive intent, the burden shifts to the defendant to show absence of confusion.  While the district court should’ve explained why Gnosis didn’t rebut the presumption, the record strongly supported a finding of actual consumer confusion.  There were only a few customers in this market, and there was evidence that several of them (as well as their own customers) were confused. Even assuming that some of Gnosis’s direct consumers weren’t confused, the record readily supported the conclusion that a significant number were misled.  Plus, the court of appeals noted, the district court’s finding of confusion could be based on literal falsity alone.

What about presuming injury to Merck?  Gnosis argued that this was only appropriate in cases of comparative advertising.  But in literal falsity cases, the Second Circuit doesn’t require extrinsic evidence of injury to consumers or to the plaintiff.  In McNeilab, Inc. v. American Home Prods. Corp., 848 F.2d 34 (2d Cir. 1988), the court of appeals held that misleading comparisons necessarily harm the victim in consumers’ minds, but misleading positive claims by the defendant injure all competitors equally, thus requiring some evidence of actual injury and causation.  The Time Warner case found that disparaging references to “cable” fell in the former category because Time Warner was cable in the relevant market.  The court of appeals now concluded that this rationale extends beyond disparagement when there is only one competitor in the market and when the deception is intentional.  “Because its only competitor for such a pure product at the time was Merck, it follows that Merck was damaged by Gnosis’s false advertising of a mixed product as a pure one.”  There was no risk that injury to Merck would be too speculative.  (I can’t see why intentional falsity is required here. Falsity would seem to work the same damage in a two-player market.)

Under the Lanham Act, a prevailing plaintiff can, subject to the principles of equity, recover defendant’s profits.  Damages can be trebled, as long as the award is compensatory and not punitive.  Willfulness is a prerequisite for a profit award in the Second Circuit.  And an award of profits may be made based on deterrence rationales, even though that’s not compensatory.  Under these standards, the district court didn’t abuse its discretion.  It reasoned that awarding profits was necessary to deter future unlawful conduct, prevent Gnosis’s unjust enrichment, and compensate Merck for its lost business, all of which are acceptable goals.  And where the parties directly competed in a two-player market, and literal falsity and willful deception have been proved, no more evidence was needed of injury and consumer confusion other than the resulting presumptions. “‘Having established falsity, the plaintiff should be entitled to both injunctive and monetary relief, regardless of the extent of impact on consumer purchasing decisions’” (citation omitted).

The district court also found that a profits award didn’t sufficiently reflect the total harm to Merck and trebled the damages.  This wasn’t a punishment or penalty, but reflected the intangible benefits to Gnosis, in particular its usurpation of Merck’s market share. The court of appeals found no abuse of discretion.  Although the statutory provision was intended to deal with hard-to-prove damages, deterrence of willful infringement is also an acceptable rationale. The facts of the case—including Merck’s exclusive control of the market prior to Gnosis’s entry, Gnosis’s continued false advertising for two years after the lawsuit began and after Gnosis’s sales agent settled Merck’s lawsuit against it and stopped distributing the mixture product—made this case “particularly appropriate” for enhanced damages. “Gnosis was unjustly enriched as a result of its false advertising, and, in light of Gnosis’s demonstrated deceptive and willful conduct—manifested by its stubborn persistence—the court’s conclusion that enhanced damages were needed to deter Gnosis from any future willful infringement was not an abuse of discretion.”  Other cases with less egregious, willful conduct might not warrant such an award.

The court of appeals also affirmed the grant of prejudgment interest (justified by willfulness again) and mandatory corrective advertising.  The corrective ads had to disclose that the campaign was court-ordered, but not that Gnosis was found to have acted willfully.  The ads had to link to the court’s opinion for context, and had to run on Gnosis’s homepage as well as product sale pages, as well as on thirdparty industry websites and in trade magazines where the offending products were or are presently advertised by Gnosis. Gnosis argued that this was unfair double recovery, but the court didn’t award Merck any damages for corrective advertising.

The court of appeals also affirmed the district court’s finding that this was an exceptional case warranting a fee award of nearly $2 million. The district court not only found that the false advertising was willful, but that “Gnosis’s litigation strategy was conducted in bad faith, with senior officials, including [CEO] Berna, frustrating the litigation process at every turn, from withholding documents in discovery and obstructing depositions to testifying falsely under oath at the bench trial in this action.”  The court of appeals noted that Gnosis had been found to engage in “egregious discovery violations,” including coaching of a witness during a deposition by the CEO, and commented that the litigation was clearly prolonged by Gnosis’s conduct.  This award was appropriate even though the fees outstripped the damages; the district court found the hours (and rates, after a reduction) reasonable.  The district court also pointed out that the actual stakes of the case (market share for one of Merck’s flagship products), as well as the level of success counsel achieved, helped justify a fee award that was substantially larger than the award of profits.  Merck didn’t get fees and costs on appeal, however, because Gnosis conducted itself appropriately in the appeal and its arguments were nonfrivolous.

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