Monday, October 17, 2016

Don't sell a business and then keep running it

Electrology Laboratory, Inc. v. Kunze, 169 F.Supp.3d 1119 (D. Colo. 2016)

Larry Paul Kunze a/k/a Lorenzo Kunzel sold his family business, plaintiff ELI (d/b/a Rocky Mountain Laser College/RMLC), “but couldn’t give it up. So, as the evidence revealed, even while negotiating the sale of ELI to the purchasers … , Mr. Kunze was trying to figure out how to continue the same business he was selling.”  The purchasers sued and, understandably, prevailed on most of their claims (though the court admirably resists the temptation to condemn all his conduct together, even the parts that would be unobjectionable on their own); Kunze did, however, show that he was entitled to relief on his counterclaim and third-party claim for breach of the Promissory Note given in partial payment for the purchase of ELI.

ELI operated RMLC to provide aesthetic laser use education and training; provided aesthetic laser services to clients; and earned income from the sale of laser equipment.  The laser education course provided 40 hours of training with a curriculum approved and regulated by the Colorado Department of Higher Education.  To market classes and sell laser equipment, ELI maintained a customer list identifying students who took the RMLC laser education course. ELI the files under lock and key and protected the lists on the computer system with a password.  ELI awarded its students “Certified Laser Specialist” or “CLS” certificates, showing they were trained at RMLC. The website at was the primary source of ELI’s ads, though it also used a number of other domain names.  Because of his many years in the industry, Kunze was well known in the aesthetic laser education industry. But:

While Mr. Kunze was a “gifted” teacher, he was not as educated or experienced as he touted. While ELI’s business and Certified Laser Specialist were recognized by some in the industry, they were also not as Mr. Kunze represented. Instead, Mr. Kunze intentionally made numerous misrepresentations … , including misrepresentations concerning the extent of his education, experience, and certifications; the number of CLS certifications that ELI had awarded to RMLC students; and that Certified Laser Specialist was a registered trademark when it was not.

After the sale, Kunze kept teaching students, employees of a former ELI student, who thought that they were getting an education from RMLC. The former ELI student believed that “what was important was receiving a certificate from ROCKY MOUNTAIN LASER COLLEGE and being taught by Mr. Kunze.” She also thought that the Certified Laser Specialist certification was important because Kunze said it was. 

Kunze taught a shorter class for his own business, American Laser College, but still used ELI’s RMLC marks and curriculum as if they were his own. He handed out RMLC business cards, and used RMLC interchangeably with American Laser College so that the students thought the entities were the same. He awarded the students CERTIFIED LASER SPECIALIST certificates, and issued the certificates under RMLC’s name. Kunze backdated the certificates as if they were issued in 2010 and put a stamp on those certificates implying the certificate or course was sanctioned by the Texas Department of Education when it was not.

Kunze also made disparaging remarks about ELI and its new owners.  He continued to compete with ELI, using its curriculum, marks, pictures, and/or information to do so.  He used RMLC interchangeably with the name of his entity, American Laser College, as if they were affiliated. “He directed customers to contact him for laser education, but used ELI’s refund and other policies along with pictures of ELI’s facilities and students to do so.” The website had no working link to ELI’s website, even though ELI was relying on the website to drive student traffic to its business.  Some of the students Kunze taught were surprised or confused when they received Certified Laser Technician certificates from an entity they had never heard of, Rock Creek.  However, the students were seeking laser certification and didn’t really care whether whether they’d be deemed Certified Laser Technicians or Certified Laser Specialists (the latters was what had been respresented to them).

After saving the information for his own account, Kunze also deleted about 60 gigabytes of data from ELI’s server, which included a list of ELI’s customers—its students and clients. There were other problems, but you get the idea.

For some of Kunze’s misrepresentations (e.g., his background and qualifications, the need for a CLS certificate), the court found no connection between them, even assuming the purchasers relied on them, and plaintiffs’ damages.  Also, ELI’s purchasers were skeptical of Kunze’s financial claims and conducted their own due diligence.  Kunze knowingly falsely represented to the purchasers that Certified Laser Specialist and CLS were registered trademarks, and these were material claims on which the purchasers relied.  ELI itself suffered damage from this—its diminished ability to protect its interest in the marks in this very suit and Kunze’s post-sale attempt to register the marks on his own behalf—but the purchasers didn’t establish damage in their own rights.  Kunze also knowingly concealed his failure to file ELI’s tax returns or pay ELI’s taxes, but that wasn’t material or harmful to the purchasers since ELI owed that amount anyway (and paying the resulting penalties only harmed ELI).  The court found that there were some breaches of contract, but not everything that plaintiffs alleged.

Defendants argued that the economic loss rule barred all of plaintiffs’ claims, including statutory claims, except for those based on breach of contract. However, a breach of a duty arising independently of any contract duties between the parties may support a tort action.  And “if the legislature intended to provide a remedy in addition to a contractual one, the statutory remedy would trump the economic loss rule.”

For trade secrets: neither ELI’s written materials nor the curriculum as a whole were trade secrets. Protection efforts were minimal, and the effort a competitor would require to recreate the materials wasn’t that great. Also, there wasn’t evidence of any “unified process, design and operation of which, in unique combination,” gave ELI a competitive advantage. “[W]hat ELI seeks to protect and to preclude Mr. Kunze from using are his skills and experience as a teacher—his interactive or engaging teaching style acquired over years of teaching the course. This is what was of great value to ELI.” But his general skill and experience isn’t a trade secret.

The student/customer list could be, and was, a trade secret, given ELI’s efforts to keep control over it.  ELI was entitled to injunctive relief and damages, including exemplary damages, for Kunze’s misappropriation of the list and use of the list to sell equipment to students.  This wasn’t precluded by the economic loss rule because state trade secret law created a duty on Kunze independent of his contractual duties.

So too with the Lanham Act claims, which didn’t arise from any contractual duty. Even if the Lanham Act claims had been within the scope of the contract, Congress intended to provide statutory rights and remedies independent of breach of contract. 

Here, Kunze’s use of the RMLC marks constituted false designation of origin, though his use of Certified Laser Specialist and CLS did not.  The RMLC marks had secondary meaning and Kunze’s use caused confusion.  But Certified Laser Specialist and CLS weren’t protectable marks, on this record.

False advertising: The Tenth Circuit hasn’t yet decided whether materiality is required separately from falsity/misleadingness, but even without materiality, ELI couldn’t win most of its claims.  ELI’s damages didn’t arise from Kunze’s misrepresentations about his “pedigree.”  Kunze intentionally and willfully

made numerous false and/or misleading statements concerning the nature, characteristics, or qualities of his goods and services. Such statements included his credentials to support his skills/abilities to perform laser education services (some false, others misleading); his affiliation with ROCKY MOUNTAIN LASER COLLEGE and ability to issue CERTIFIED LASER SPECIALIST certificates (false); that ROCKY MOUNTAIN LASER COLLEGE and American Laser College are affiliated or the same (false); and that CERTIFIED LASER SPECIALIST is a registered trademark (false).

The RMLC affiliation-related claims were material, but not the others. “[W]hile the evidence supports that receiving some certification was important to the consumers, for many consumers it mattered not whether it was a CLS or a CLT.”  Since the RMLC affiliation-related claims were literally false and intentional, no evidence of confusion was required; ELI was damaged thereby because students signed up for Kunze’s courses thinking they were RMLC courses but didn’t get RMLC certificates, so RMLC suffered in both sales and reputation.

The court exercised its equitable discretion to treble the damages it found ELI to have suffered (lost class revenues) because overall damages were hard to ascertain and Kunze’s actions were willful.  Because this was an “exceptional” case, the court also awarded attorneys’ fees.  Kunze “intentionally used ELI’s marks for his own benefit … and he continued to use the marks even after the Amendment was terminated and ELI requested Mr. Kunze to stop doing so. Mr. Kunze offered no credible explanation as to why he was entitled to do so.”  The court also awarded prejudgment interest.

Colorado Consumer Protection Act: The CCPA requires a significant impact on the public, for which relevant considerations include: “(1) the number of consumers directly affected by the challenged practice, (2) the relative sophistication and bargaining power of the consumers affected by the challenged practice, and (3) evidence that the challenged practice has previously impacted other consumers or has the significant potential to do so in the future.” Making defamatory statements about ELI was purely a private wrong.  However, the false website advertising directed to the market generally had a public impact, given the length of time and the number of websites on which Kunze posted his false and misleading advertisement.  Students were likely to be unsophisticated consumers with bargaining weaknesses, and some enrolled believing they’d get a RMLC certificate.  However, there was insufficient evidence that Kunze’s false claims about his affiliations with other organizations, his credentials, and the like affected any consumers.  Given the court’s finding of bad faith in the actionable misrepresentations, it also trebled ELI’s damages under state law.

Kunze also lost on defamation/libel per se based on statements to ELI’s landlord, one plaintiff’s banker, ELI’s laser supplier, and ELI’s students.  The plaintiffs were private figures, and the statements were defamatory per se (about ELI’s financial solvency), so defamation was presumed; the court awarded a total of $50,000.

The court also granted injunctive relief.  ELI would suffer irreparable harm because competing sales of laser equipment would erode its customer base, and damages would be difficult to determine because ELI wouldn’t be able to monitor Kunze’s sales.  “ELI presented insufficient evidence of continuing sales to support an award of damages subsequent to the termination of the parties’ relationship, but it is this very difficulty in discovering Mr. Kunze’s use (and resulting damages) that supports the issuance of injunctive relief.”

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