Thursday, September 18, 2008

Payless to pay less

Adidas America, Inc. v. Payless Shoesource, Inc. (D. Or.)

A couple of interesting rulings out of the district court’s decision to deny a new trial on damages, conditioned on adidas’s acceptance of a substantial remittitur.

On dilution, Payless argued that it didn’t use two or four stripes on shoes as its own trademark, but merely for decoration, thus falling outside the TDRA. The court disagreed that subjective intent controlled. The question was whether consumers perceive Payless’s use as a trademark “so that the value of the mark to adidas is diluted.” This can happen even if Payless does not deliberately promote the stripes as its own trademark. So, the court apparently accepted the “use as a mark” requirement, but found it satisfied by evidence of consumer perception (this evidence appears to be standard branding bull, rather than survey evidence, which further weakens the “use as a mark” requirement as a constraint on dilution liability). Mark McKenna has argued that this is the natural result of current trademark thinking and that it makes “use as a mark” a fairly useless limit.

Speaking of evidence: adidas had no evidence of lost sales. Instead, its marketing expert testified that the infringement damaged the “distinctiveness, perceived quality, positive consumer associations, and consumer loyalty” of its brand, even though sales continued to grow during the period of infringement. The court ruled, however, that loss of the ability to control a reputation for quality is a legally cognizable form of injury. A couple of things about that: first, that doesn’t mean that the damages from “loss of ability to control” can be measured in any rational way; in most tort cases, courts don’t like to compensate people for risk alone, though perhaps “market monitoring” might be appropriate damages, like medical monitoring.

Second, the line of cases about loss of ability to control as damage presuppose that the parties do not compete; courts were trying to explain why there could be infringement without lost sales. Yale Electric Corp v. Robertson, 26 F.2d 972, 974 (2d Cir. 1928) (“[A] merchant may have a sufficient economic interest in the use of his mark outside the field of his own exploitation to justify interposition by a court. …. If another uses it, he borrows the owner’s reputation, whose quality no longer lies within his own control. This is an injury, even though the borrower does not tarnish it, or divert any sales by its use . . . .”). Where the parties do compete, infringement should mean lost sales; if there are no lost sales, the infringement story is just unpersuasive. Here, the expansion of trademark liability to cover noncompeting goods has actually increased the scope of liability as between competing goods; it seems to me that accepting this story for competing goods is like allowing dilution claims on competing goods—it allows trademark owners to suppress competition without any justification in consumer protection.

Anyway, the formal doctrine is that plaintiffs have to prove the fact and the amount of damage. But in the Ninth Circuit, plaintiffs can still recover damages based on the “totality of the circumstances.” Here, that evidence came essentially from two marketing experts who repeated standard claims about brand value; the court accepted their testimony even though they couldn’t quantify the harm.

Nonetheless, the court still ruled that the jury’s random number used for damages was too large.

First Payless challenged the $30.6 million “reasonable royalty” calculation. Even though adidas would not have licensed its mark, the court accepted this as an appropriate part of a damages calculation. The Lanham Act allows recovery of damages, which can be adjusted up (but not down) if necessary to compensate the plaintiff, but can’t be a penalty. A hypothetical reasonable royalty can be a measure of actual damages in a trademark case. Here, the royalty would have resulted in a loss to Payless given the price at which it sold the shoes, but that didn’t make it unreasonable; a royalty can wipe out an infringer’s profit.

Second, Payless challenged the award of profits. Profits can only be disgorged in cases of willful infringement; the court rejected Payless’s argument that willfulness needed to be shown by clear and convincing evidence. The court endorsed the jury’s willfulness finding. However, the time period of the willfulness was limited: there was a 1994 settlement agreement that Payless believed governed its conduct, and two federal judges adopted Payless’s interpretation of the agreement. Moreover, many other companies sold four- and two-stripe shoes. Though the Ninth Circuit reversed the district court three years later, Payless wasn’t behaving willfully until it refused to change its conduct after the court of appeals acted.

However, adidas was “very aggressive” in calculating Payless’s profits; the judge concluded that adidas overstated the profits and didn’t follow generally accepted accounting principles. For example, it didn’t deduct the royalty as an expense of selling the shoes, which meant its calculations included a double recovery. The adidas expert argued for $208 million in profits, but admitted that a commonly used measure would result in a figure of $19 million, close to the Payless expert’s calculation. The order of magnitude difference demonstrated the unreasonableness of the jury’s award ($137 million). Thus, the court found that $19.7 million was the appropriate award of profits.

The Lanham Act doesn’t make punitive damages available (and in fact instructs against damages as penalties). The jury awarded $137 million on adidas’s common-law infringement/unfair competition claims. Payless argued that differences in state laws, as well as general due process considerations, precluded this award. For example, some states require clear and convincing evidence; others cap punitive damages. Because the jury awarded a punitive amount equal to its finding of Payless’s profits, Payless argued, it clearly and illegitimately awarded punitives based on 50 states’ worth of conduct.

Adidas argued that the punitive award was justified because the harm was felt in-state, where its North American headquarters are. State Farm Mutual Automobile Insurance Co. v. Campbell, 538 U.S. 408, 421-22 (2003), held:

A State cannot punish a defendant for conduct that may have been lawful where it occurred. Nor, as a general rule, does a State have a legitimate concern in imposing punitive damages to punish a defendant for unlawful acts committed outside of the State’s jurisdiction.

The court, however, was “not convinced” that State Farm applied, because State Farm’s business practices in numerous states bore no relation to the particular bad-faith conduct underlying the plaintiff’s claim. However, here the conduct all related to Payless’s infringement of adidas’s marks. (I don’t see how this answers the objection that, say, in Louisiana that infringement could not be punished with punitive damages; it is possible that Oregon has a sufficient interest in adidas’s health that it can punish Louisiana-based conduct with Oregon rules, but it seems to me that argument needs a bit more attention.)

In any event, the court accepted the alternative argument that the punitive award violated due process. Under State Farm, courts must consider

(1) the degree of reprehensibility of the defendant’s misconduct; (2) the disparity between the actual or potential harm suffered by the plaintiff and the punitive damages award; and (3) the difference between the punitive damages awarded by the jury and the civil penalties authorized or imposed in comparable cases.

(1) is most important, and requires consideration of whether the harm was physical or economic; whether defendant’s conduct showed indifference to or reckless disregard of health or safety; whether the target was financially vulnerable; whether the conduct was repeated or isolated; and whether the harm was intentional, malicious, deceitful, or mere accident. In practice, few awards exceeding a single-digit punitive:compensatory ratio will be acceptable.

Here, the harm was entirely economic and there was no evidence of lost sales or financial vulnerability. But the conduct was repeated—267 lots of shoes infringed—and the infringement was no mere accident. However, for 3 years Payless believed that the district court’s opinions allowed the sales.

The second factor is the disparity between the harm and the punitive damages. The first issue, the court noted, was what numbers the court needed to compare. The $30.6 million royalty was compensatory. The award of Payless’s profits was to prevent unjust enrichment. Though profits are part of the recovery allowed, they do not count as harm suffered by the mark owner for purposes of due process analysis. Thus, the court compared the royalty award with the punitive award, producing a 4.5:1 ratio. This in itself did not offend due process. However, where compensatory damges are substantial, a lesser ratio, “perhaps only equal to compensatory damages, can reach the outermost limit of the due process guarantee.” State Farm, 538 U.S. at 425. The royalty award was substantial, especially given that adidas lost no sales and the damages were “theoretical.”

After considering the guideposts, the court concluded that even a 1:1 ratio was too high. This was unusual, but not unknown in cases involving only economic harm. Thus, the court denied Payless’s motion for a new trial, conditioned on adidas accepting a remittitur of the punitives to $15 million.

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