First sale slightly protects unauthorized reseller

Bel Canto Design, Ltd. v. MSS HiFi, Inc., 2011 WL 6355215 (S.D.N.Y.)

HT Eric Goldman. Bel Canto sells high-quality audio components and owns registered trademarks for its marks with significant goodwill.  Bel Canto’s products have serial numbers, which Bel Canto tracks for invoicing and warranty purposes, and in order to sell legally in Canada.  Bel Canto products are supposed to be sold only through a network of authorized dealers, who are prohibited from selling them to unauthorized dealers.  Bel Canto refuses to honor the manufacturer’s warranty or provide product and service assistance, product use information, software upgrades, rebates, and recall notices to consumers who buy from unauthorized dealers.

Defendant MSS was an authorized dealer in 2009 but was terminated in 2010.  It still offered Bel Canto products in its stores and on its own and other websites.  MSS got Bel Canto products from authorized dealers who were violating their dealer agreements.  MSS advertises on its website that it will buy authorized dealers’ inventory in violation of their OEM agreements:

Need to place a $50k or $100k order with a manufacturer in order to get the  proper discount? JB Audio can be your secret investor. We are very discreet, and we already have arrangements with a number of dealers to keep the big brothers guessing. We will do everything in our power to protect your interest.

Defendant John Boey owns MSS; Bel Canto terminated MSS when it learned that Boey was involved.

MSS altered Bel Canto serial numbers. Bel Canto found out about this when a French customer contacted it to complain that he hadn’t received the product he’d ordered from MSS, which MSS had told him would be altered by the Bel Canto factory to change the voltage from standard US current to European current.  Shortly after that, MSS shipped the customer a different product than the one he’d originally ordered.  MSS obtained the product from an authorized Bel Canto dealer.  Bel Canto investigated and found the serial number on the unit to be counterfeit: the exterior serial number didn’t match the interior serial numbers.  Bel Canto determined that this had been done to hide the identity of MSS’s supplier (who it then terminated).

Bel Canto then looked into MSS’s eBay listings and concluded that it was listing products with counterfeit serial numbers.  Also, MSS explicitly or implicitly misrepresented to consumers that Bel Canto would alter the voltage from US to European, but Bel Canto won’t do that for products sold by unauthorized dealers.  MSS also claimed that it would modify the products, but such alterations by unauthorized technicians may pose a risk to consumers since improperly performed alterations may cause injury or damage to property.  Such voltage conversions require removal of the product’s casing.

Bel Canto does not honor warranties for products sold by unauthorized dealers, while new Bel Canto products sold through authorized Bel Canto dealers have at least a two-year parts and labor limited warranty. Bel Canto also refuses to honor the warranty of a product bearing an altered serial number, regardless of whether the product was sold by an authorized or unauthorized dealer. Finally, Bel Canto will also refuse to honor the warranty of a product that has had its casing opened by anyone other than an authorized service provider. It discloses these things on its website.  Many manufacturers in the industry have similar policies.

Bel Canto wants to control the presentation of its products in display rooms; absent an incentive to have knowledgeable dealer employees and good demonstrations available, dealers might not think it’s worth the trouble to do so.  Thus, if customers can easily find the same products at lower prices online from unauthorized dealers, who don’t have the burden of brick-and-mortar overhead, dealers might not want to carry Bel Canto products, which are generally sold only after an audition. MSS doesn’t have a retail store with display rooms that would meet Bel Canto’s standard for providing an appropriate atmosphere.

Bel Canto also only wants authorized dealers who give consumers good experiences, since consumers may not differentiate between the manufacturer and the dealer if they have bad experiences.  Boey has a felony record; Bel Canto doesn’t want to associate with such people.  Moreover, MSS competes unfairly with authorized dealers in other countries: if asked by a customer, MSS won’t declare the proper value of the goods it’s shipping, allowing customers to evade customs taxes.  Bel Canto authorized dealers aren’t allowed to make false customs declarations.

MSS also said things on its website to which Bel Canto objected, including claims that MSS was the "exclusive online headquarter [ ]" for all Bel Canto Design products; that Bel Canto's national sales manager would attend an event at a MSS store; that Bel Canto endorsed MSS as a dealer; that Bel Canto and its national sales manager endorsed the disclosure of inaccurate wholesale pricing information; that Bel Canto's lawyers believed that MSS was "best suited" to present Bel Canto products to the world; and that voltage conversions performed by MSS are as good as those performed by Bel Canto licensed technicians.

Bel Canto received a TRO in August 2011 forbidding defendants from selling Bel Canto products with altered serial numbers or making any claim of affiliation with Bel Canto or otherwise "defaming, diluting, or causing confusion with respect to Bel Canto or its trademarks ...." In September the TRO was expanded to require an affirmative disclaimer of affiliation on MSS’s site stating that MSS “IS NOT AN AUTHORIZED BEL CANTO DESIGN DEALER. ANY BEL CANTO DESIGN  PRODUCTS PURCHASED FROM MSS HiFi DO NOT HAVE A MANUFACTURER'S WARRANTY, and WILL  NOT BE ELIGIBLE FOR (i) SERVICE FROM BEL CANTO DESIGN, (ii) SOFTWARE OR HARDWARE  UPGRADES, (iii) REBATES, or (iv) ANY RECALL OR OTHER NOTICES.”  You know, allcaps doesn’t work very well for long statements, but people apparently like it anyway.  It’s so shouty.

Now the court was looking at a preliminary injunction.  It divided MSS’s conduct into persistent and one-off activities.  The persistent conduct was the repeated claim on MSS’s website that it was Bel Canto's "exclusive online headquarter." Surprisingly, the court found these statements not actionable.  First, this was not false because there was no evidence that other online retailers offered Bel Canto proucts, because of Bel Canto’s business model.  It was therefore not misleading to call defendants the “exclusive” source, or even the “headquarter” (argh!) for online Bel Canto products.  This didn’t suggest a legal or business relationship between the parties and wouldn’t confuse consumers. 

Second, defendants carefully avoided any reference to being an “authorized” Bel Canto dealer.  The difference between exclusivity, which can and does result from factors other than a relationship between two parties, and authorization, was significant. No injunction against the "exclusive online headquarter[s]" statement so long as it remained true.

However, Bel Canto also identified false statements that likely did violate the Lanham Act.  The false statement that Bel Canto’s national sale manager planned to attend a MSS promotion featuring Bel Canto’s full line of products did suggest a business relationship.  Boey also directed a friend to post a comment on MSS’s website under the name “Larson and Ricko,” purporting to be authorized by Bel Canto attorneys Larsen and Rico, “confirming” that the manager would be there to “officially endorse” MSS as the “Online Headquarter for all [Bel Canto] products,” with a laudatory statement about Boey.

These false statements were likely to cause confusion.  The court applied the rule (at best, deeply uncertain after eBay and Salinger) that likely confusion creates a presumption of irreparable injury; therefore, Bel Canto showed irreparable injury.  Voluntary cessation may negate the need for injunctive relief if there’s no danger of recurrent violation.  However, the evidence demonstrated that Boey posed a risk of recurring violations.  Even after the first TRO, Boey persisted in bad behavior.  For example, after the first TRO, defendants disparaged Bel Canto by claiming that Bel Canto's ratings of its own products were "deceiving."  (Is that defamation?  Without more detail, it’s hard to know, and a TRO that covers simply saying nasty, nonfalsifiable stuff about Bel Canto sounds like a First Amendment problem.)  More persuasively, the court noted evidence of Boey’s past falsehoods about affiliation with Stereo Exchange, an MSS competitor and authorized Bel Canto dealer. In combination with “the unquantifiable nature of the injury” his false claims inflicted, the risk of recurrence justified injunctive relief. 

This injunction would be limited to prohibiting other false claims of endorsement, not a mandatory injunction altering the status quo.  The “extreme remedy” of an affirmative disclaimer was unnecessary. 

Bel Canto also sought an injunction barring defendants from selling Bel Canto products with altered serial numbers.  Defendants argued that they were protected by first sale; the court disagreed.  Trademark law doesn’t confer on trademark owners the right to control subsequent unauthorized resales of genuine products.  Material differences mean a product isn’t genuine.  Not every difference between a product in its first sale state and its resale is material.  The guiding principle is whether the difference confuses consumers.  However, because many factors influence consumers, the threshold must be kept low to include even subtle differences.

The material difference exception to first sale is a proxy for the ultimate inquiry into confusion. “[W]hen a defendant sells a product that is materially different, but has the exact same appearance as a plaintiff's product, it is presumed likely that the undisclosed difference between the products will confuse consumers and damage the plaintiff's good will.”  The implicit corollary is that sufficient disclosure of the difference dispels any confusion (e.g., “used” for a car).  

Defendants argued that MSS customers were getting genuine Bel Canto products.  They didn’t replace the original parts with inferior ones, or even offer different accessories.  Bel Canto argued that there were material differences because the external serial numbers had been altered.  The Tenth Circuit has held that a physically identical product is nevertheless "materially different" from the genuine article if "the bundle of services" that attach to the genuine article ia not available to the consumer, which can occur if the serial number is altered and the manufacturer therefore won’t honor the warranty.  Likewise, the Second Circuit has held that physically identical Cabbage Patch Kids dolls were materially different because the unauthorized imported dolls came with Spanish “birth certificates” and “adoption papers” instead of English.

Thus, if defendants were selling Bel Canto products that lack warranty and other services such as upgrades and recall notices without alerting their customers, there’d be material differences and first sale wouldn’t protect defendants.  However, the court found a complication.  Because MSS is a New York dealer, Bel Canto’s policy of refusing to honor warranties solely because a product was purchased through an unauthorized dealer was trumped by section 369-b of the New York General Business Law:

A warranty or guarantee of merchandise may not be limited by a manufacturer  doing business in this state solely for the reason that such merchandise is sold by a particular dealer or dealers, or that the dealer who sold the merchandise at retail has, since the date of sale, either gone out of business or no longer sells such merchandise. Any attempt to limit the manufacturer's warranty or guarantee for the aforesaid reason is void.

A previous case suggested that a blanket disclaimer of warranties for “unauthorized Internet sellers” might be too general to fit into the statutory language.  But the court here thought that “particular dealer or dealers” was not so limited.  The practice commentary noted that the purpose of the section was to prevent enforcement of precisely the kind of policy at issue here: denying service to customers because goods were sold by unauthorized dealers.

Bel Canto argued that the law might not apply, at least not to non-NY customers.  This was an issue of first impression.  Applying the general principles of NY consumer protection laws, the court concluded that all MSS customers were entitled to the law’s protection because the transactions in which they purchased their goods were “New York transactions.”  All the evidence was that MSS sold/accepted and filled internet orders in New York.

As a result, Bel Canto couldn’t rely on MSS’s non-authorized status to establish a material difference in the absence of warranties or other services (which were themselves contingent on valid warranties; the court didn’t address what would happen if Bel Canto tweaked its policies to honor warranties but deny upgrades etc., though that might be easier to disclose/less material to consumers). 

Bel Canto wasn’t entirely out of luck—in some instances, it refused to honor warranties on other, valid bases. “For example, if a dealer is known to the manufacturer to handle the product in a negligent manner, risking damage before the product reaches the consumer, the manufacturer remains free to refuse to honor all warranties from that particular dealer.”  Bel Canto refused to honor warranties for products that had their serial numbers altered, even though it didn’t say so on its website.  The court found that the reasons for doing this made sense, because accurate external serial numbers were important to quality control and recalls.  Unauthorized resales that interfere with a mark holder’s ability to exercise quality control are outside the protection of first sale.  (Here the court quoted cases that apparently omit a confusion requirement, equating sale of goods that don’t meet the TM owner’s quality control standards with infringement, though it described these as cases in which the defense that the defendant was doing nothing more than selling genuine articles was countered with evidence that the defendant’s conduct interfered with quality control.  I still don’t get what’s likely confusing about such conduct, as opposed to theoretically confusing, but here’s another court explaining that “the interference with the trademark holder's legitimate steps to control quality  unreasonably subjects the trademark holder to the risk of injury to the  reputation of its mark.”)

Here, Bel Canto’s use of serial numbers to track components and institute targeted recalls, if necessary, meant that even if altered serial numbers didn’t qualify as material differences, the interference with quality control constituted a basis for relief.  Thus, selling products with altered serial numbers risked consumer confusion.  (What if the serial numbers are simply removed, and there’s disclosure?) 

Defendants argued that there was no evidence of actual confusion, but that’s not required.  “Bel Canto does not need to adduce evidence from customers who unknowingly bought a product with a fake serial number, sought and were denied warranty service, and developed a negative impression of Bel Canto as a result. It is enough that such an outcome is likely given Bel Canto's legitimate policies and Defendants' practices.”  Moreover, the experience of the French customer demonstrated likely confusion; US customers were similarly situated in all relevant respects.

Defendants argued that the interior serial number remained on the product, but that was irrelevant.  It was enough that Bel Canto had a legitimate policy that gave rise to a material difference.  Moreover, the interior numbers wouldn’t help owners figure out if they were targeted by recalls unless they knew about the exterior alterations, and they couldn’t look for interior serial numbers without cracking the case and voiding the warranty (a Bel Canto policy that was obviously permissible).  Defendants had no right to put customers in that Catch-22.

In addition, products sold overseas were therefore materially different, because MSS had cracked the case to perform the voltage conversion, voiding the warranty. “[T]his practice too makes the products that Defendants sell not genuine, risks consumer confusion and damage to Bel Canto's goodwill, and therefore constitutes infringement under the Lanham Act.”  (Again, the court didn’t address whether a disclaimer could solve the problem.)

So, the court granted an injunction barring defendants from making false claims of affiliation with or endorsement by Bel Canto; from advertising or selling any Bel Canto product with an altered serial number (I wonder whether this covers removal); and from advertising or selling any Bel Canto product as to which defendants had taken steps that voided the warranty, including cracking the case.