Defendant hits the trifecta, loses copyright, Lanham Act, and design patent claims

Victor Stanley, Inc. v. Creative Pipe, Inc., 2011 WL 4596043 (D. Md.)

Extremely bad behavior drove the court’s (unnecessary) misinterpretation of Dastar.

Plaintiff VSI makes site furnishings such as benches, planters, bike racks, etc. It produces them in America and invests heavily in technology. This investment includes production of technical drawings, including CAD drawings, used in manufacture and sales. The court found that the drawings have substantial economic value. VSI created an online product library containing its CAD drawings, specifications, and product images, accessible by customers, architects, and designers, for specific use in project design and purchasing activities such as presentations and bid documents.

Mark Pappas owns Creative Pipe, Inc., based in California. He tried to design site furnishings in the US but sold only about two dozen. He attempted to get a foothold in the market by falsely claiming to represent VSI. Defendants also copied VSI’s products and sold them under the trade name FUVISTA, which stands for "F--- You Victor Stanley." In the course of the ensuing litigation, defendants engaged in massive spoliation of evidence. This led to a default judgment of liability on the copyright infringement count, as well as an award of attorneys’ fees and costs.

The case proceeded to trial on damages for copyright infringement and on VSI’s claims for unfair competition, false advertising, and patent infringement.

Given defendants’ behavior, the court was not kind on damages. Pappas obtained access to the VSI library by falsely identifying himself and falsely representing his purpose. He copied the drawings and substituted CPI’s name on the drawings for VSI’s. (Why no CMI removal claim?) He then made additional copies and used them in the course of CPI’s business, including them with bids submitted for the sale of Fuvista products and sending them to contractors, largely in China, to produce the products.

Since the drawings weren’t registered before the infringement began, VSI sought damages based on the infringer’s profits. The drawings must be distinguished from the objects they depict, as to which there’s no copyright protection, and that might have mattered in a different case. No one would infringe by reverse engineering a VSI product, though the court commented that there could be “debatable issues” if defendants used, without copying, a VSI drawing to manufacture products. I can’t see what the debatable issues would be, given that the court acknowledged that the products themselves would not be infringing.

Here, defendants downloaded and transmitted the drawings, caused contractors to create derivative works, transmitted the infringing derivative works, made copies of them in bids, and caused foreign contractors to copy the infringing works. (It’s not clear that there’s US infringement in that last one, but again it doesn’t really matter here.)

In recovering profits, the copyright owner must present only proof of the infringer’s gross revenue, and the infringer is required to prove deductible expenses and elements of profit attributable to factors other than the copyrighted work. There’s an obvious baseline question here: should we assume that the sales of the products would have occurred anyway via reverse engineering, meaning that profits from sales of the products themselves are not attributable to the copying, or should we look to what the profits would have been if they didn’t put the products on the market (since the copying was a but-for cause of the sales)?

The court went with the latter: “Profits attributable to the infringement can include profits derived from the sale of products if those sales are attributable to the copyright infringement.” The court found that defendants failed to meet their burden to show that sales of their “VSI-like products” were attributable to something other than copyright infringement. The court didn’t explicitly say that defendants failed to show that they would have reverse engineered if they hadn’t copied, but I think that’s both plausible in this case and the only way to make this analysis work. So nearly $2.4 million in revenue was reasonably related to infringement (and it was likely that the amount was substantially more but unascertainable due to defendants’ spoliation).

The infringer has the burden of showing deductions, and courts are especially dubious when infringement is willful, which it was here. “Pappas knew that the VSI product library contained original works that were owned by VSI, but he deliberately copied them using a false identity, removed the VSI identifiers and replaced them with CPI identifiers. Then he caused the evidence of these actions to be destroyed.” Plaintiff’s expert credibly opined that gross profit should be determined by reducing gross revenue by 51.28% to take into account cost of goods sold and net freight, producing a bit over $1.15 million in gross profit. The court denied defendants’ claimed deductions and also awarded prejudgment interest at 6%, increasing the award by over $200,000.

VSI also brought a state law unfair competition claim against defendants. Defendants argued copyright preemption. But there was an extra element here: deception, as in passing off, so there was no preemption. The court found that VSI proved misappropriation of its IP and goodwill, including “copying and using the drawings to solicit business and manufacture competing products, falsely representing VSI's drawings as CPI's, falsely representing CPI as an equal to VSI in the marketplace, and mimicking VSI's advertising, style, and marketing themes.” VSI also proved harm. In one project, the parties were the only two directly competing bidders, and CPI won the bid “using an altered drawing derived from a copyright protected original drawing that was downloaded without authority from VSI's product library.” Moreover, CPI’s bids for VSI-like products were based on the deceptive claim that the products were made "in house" in the United States, forcing VSI to reduce its prices.

Defendants “engaged in a massive degree of unfair competition directly aimed at VSI.” Aside from the copyright infringement, defendants created the false impression that CPI “was comparable to VSI as an American manufacturer of quality site furnishings, with 50 employees, a unique powder coating process and facilities, and made all its goods ‘in house.’ In fact, CPI had four employees, no manufacturing facility, had products manufactured in China, and removed the country of origin labels.” This unfair competition increased its profits.

The court awarded VSI defendants’ profits attributable to unfair competition—the sale of VSI-like products. Thus the court awarded the same amount as for the copyright infringement claims. Punitive damages are available under Maryland law only for actual malice. Actual malice must be proven by clear and convincing evidence. This standard was satisfied here, making it one of the rare cases in which a state-law claim is actually worth something over and above a Lanham Act claim. Defendants’ acts were deliberate, with wrongful motives and ill will specifically directed at VSI, evidence of which includes choosing and publicizing the meaning of the name Fuvista, and “ranting and raving” about VSI.

The amount of punitive damages shouldn’t be disproportionate to the defendant’s ability to pay. Under the circumstances, a $500,000 award was appropriate, taking into account the award of enhanced damages on the Lanham Act claim (coming up next). If that enhanced damages award were to be reversed on appeal, the court indicated that it would increase the punitive damages award by the same amount.

There was no legal authority under Maryland law to award attorneys’ fees on this claim.

For the Lanham Act claims, VSI first alleged reverse passing off of its drawings as originating with CPI. This is clearly barred by Dastar, which focuses on the origin of the tangible copies at issue. The tangible copies here (even if only tangible in the sense of being stored in a computer’s memory) are those made by defendants. That’s why they infringed VSI’s copyrights. The court even points out, above, that if defendants had used VSI’s own copies to produce the products this would have been a very different case.

The court, however, bollixed this. “VSI is the source of the technical drawings. The evidence showed, in numerous instances, that Defendants downloaded the drawings [ed. note: that is, copied the drawings, creating their own infringing copies] from the VSI product library, removed the VSI source information and product name from the [copies of the] drawings, replaced the source information [on the copies] with representations that CPI had created the drawings, and replaced the VSI product name [on the copies] with a CPI product name.” Indeed, as described, it seems certain that there were multiple generations of copies before defendants’ copies found their way to someone who might be confused by this.

The court stated that the Fourth Circuit has found reverse passing off liability in “similar circumstances,” which is not true. Universal Furniture International v. Collezione Europa USA, 618 F.3d 417 (4th Cir. 2010), found liability for both copyright infringement and reverse passing off where the defendant removed the competitor's indicia of ownership from the products and displayed them as defendant's own, even though it did not actually sell the displayed products but fulfilled sales with its own manufactured products. Removing the indicia from the physical products displayed to induce sales was reverse passing off (“Collezione had simply removed Universal stickers from some pieces. In some instances, [Universal’s principal] noticed stickers (which he had designed) bearing the name of Universal's manufacturer, Lacquercraft.”). But the copyright infringement stemmed from different acts, in that case reproducing infringing articles—the furniture designs themselves were copyrightable, unlike the situation here.

Universal is thus inapposite. Saying that “VSI's technical drawings were presented to consumers as CPI drawings for CPI products, and consumers were likely to be misled into believing that CPI was the source of the drawings” is to make the mistake the Court rejected in Dastar--treating the source of the expression in the physical object as “origin” for purposes of §43(a)(1)(A). CPI was the source of the particular copies of the drawings it presented to consumers; those copies were therefore infringing copies.

The court then found that consumers were likely to be confused into believing that CPI was “a ‘genuine’ designer and producer of VSI-like products in an ‘in-house’ American production facility. A truthful presentation of the drawing submitted with a CPI bid as a drawing that originated with VSI would have been less effective, if it would have been accepted at all.” This conclusion highlights that the false designation claim is completely unnecessary: as the Court indicated in Dastar, in some circumstances false advertising claims against copying will be viable. The court isn’t even targeting the copying here—it’s the context, including the claims to design in-house, that makes the copying deceptive.

Anyway, the court concluded that defendants obtained customers who otherwise could have bought from VSI “and thus deprived VSI of the benefit of the attendant goodwill and enhanced reputation as the creator of the drawings,” and also caused the lost sale in the instance when the parties had competing bids for the same job.

Disgorgement of profits under the Lanham Act requires consideration of (1) the defendant’s intent to confuse or deceive; (2) whether sales were diverted; (3) the adequacy of other remedies; (4) any unreasonable delay by the plaintiff in asserting its rights; (5) the public interest in making the misconduct unprofitable; and (6) whether it is a case of passing off. So, obviously, disgorgement was justified, in the same amount as above—the profits from copyright infringement plus prejudgment interest.

In addition, the Lanham Act allows an award of up to three times the amount found as actual damages, as long as it’s for the purpose of compensation instead of penalty. Enhancement may be based on willfulness as long as it doesn’t become a penalty (and yet the court’s perfectly happy to recategorize these enhanced damages as punitive damages). Enhancement can help when “imprecise damage calculations fail to do justice, especially where the imprecision results from the defendants' conduct.” This was the case here: given the willful infringement and defendants’ spoliation of evidence, the court awarded enhanced damages of one-half of actual damages. If the punitive damages award above were to be reversed on appeal, the court would add half a million dollars to the enhanced actual damages under the Lanham Act.

This was also an exceptional case entitling VSI to attorneys’ fees.

On to the actually valid false advertising claim: CPI made a number of misrepresentations: (1) It claimed to offer a safety bollard capable of stopping a 15,000 pound vehicle traveling at 50 miles per hour that had been independently crash-tested and found to achieve a Department of State "K-12" rating; (2) it claimed that the Nebelli and Necati benches were ADA-compliant, although there are no ADA requirements, either mandatory or voluntary, that apply to outdoor benches; (3) defendants claimed that CPI products were made by CPI in two United States manufacturing facilities; (4) CPI claimed that all of its work was done in house, and that it had its own state-of-the-art in-house powder coating facility; (5) CPI claimed it developed a method of manufacturing its site furnishings that resulted in unsurpassed strength and integrity.

The court found that one alleged falsehood, that CPI was developing “progressive and functional new designs,” was puffery. Even though its products were bad, past failures weren’t enough to make this claim false: “Reasonable potential purchasers are unlikely to rely on the statement as one of fact rather than opinion and are capable of determining whether the designs they see are progressive or functional despite what the seller boasts. There is insufficient evidence to find this general and subjective statement anything more than non-actionable puffery.” Interestingly, and I think correctly, the framing of this statement suggests that extrinsic evidence could have changed the court’s conclusion in appropriate circumstances; sometimes we need to know more about the relevant consumers before we can be sure what they’d think was a factual claim.

However, “unsurpassed strength and integrity” was capable of being measured and thus not puffery. CPI argued that it made a bald claim, not a “tests prove” claim, and thus VSI was required to prove falsity. Fortunately for VSI (though not for CPI’s clients), VSI introduced testimony that defendants’ products were inferior. A VSI vice president with responsibility for product design and manufacturing testified, for example, that trash receptacle doors must open thousands of times for removal of trash, and CPI used welded hinges with pins that bend over a fairly short period of time causing the doors to go out of alignment. Also, VSI relied on emails from Pappas to a subcontractor describing products rejected by customers, saying they "never should have passed your quality control inspection" and that the problems identified "call into question the quality of all the products you are making for me." There was no rebuttal evidence, and thus the court found the claims about strength and integrity false.

All the actionable statements were material and likely to deceive consumers. For example, VSI received calls from landscape architects “asking if VSI products were ADA-compliant, because they did not want to have to replace products to meet the requirement (even though there is no such standard).” This was an indicator of materiality, as was the importance of meeting a Homeland Security standard for “security bollards that were being placed outside buildings to prevent explosive-laden trucks from crashing into buildings. These are not claims that buyers take lightly.” Also, VSI submitted evidence that some buyers require (not just prefer) American-made products. “Made in America” was material even if it’s just a preference. “The very actions of Pappas to ensure that the ‘Made in China’ labels were removed from CPI's products provide eloquent testimony of the materiality of the misrepresentation as to the origin of the goods.”

Injury: here, the court found that it would be difficult to show that CPI’s sales would generally have gone to VSI, because there are a number of competitors in the market, but it was still likely that some sales would have gone to VSI as a genuine American manufacturer when CPI was awarded bids on the basis of its false origin claims. Also, there was harm to everyone in the market, including VSI, in having respond to “China prices.” Moreover, VSI provided testimony of likely harm to its reputation due to the poor quality of the CPI "knock-offs" that may be mistaken for VSI products. (Whoa! That’s not the same claim at all, and would be a §43(a)(1)(A) claim.) Anyway, VSI had been harmed by sales diversion and lessened goodwill.

VSI sought only injunctive relief, not damages, on its false advertising claims. (Note that the damages to VSI here are likely to be different from the damages based on the copying/knock-offs, though disgorgement of profits would still seem available.) VSI demonstrated irreparable injury to its reputation and goodwill, and the other factors also favored injunctive relief. VSI also got attorneys’ fees on the false advertising claim.

But wait, there’s more: design patent infringement. This is determined using the ordinary observer test. “[I]f an ordinary observer, familiar with prior art designs, giving the degree of attention normally given by a purchaser, would be deceived into believing that the Defendants' benches are the same as VSI's design, there is infringement.” Minor differences don’t prevent an infringement finding; the focus is on the overall design impression.

The court, considering the relevant prior art cited to it, found that the Nebelli bench infringed VSI’s patent. The prior art, the Chipman patent, has front and back legs oriented differently from those of VSI’s patented bench, and its seat projects beyond the end of the arm rest, creating a different overal impression. The minor differences in the Nebelli bench end frame and the patented bench were not enough to allow an ordinary observer familiar with the prior art to easily distinguish them.

However, the Necati bench was not substantially the same as the patented bench. VSI argued that the additions were trivial, but the court found that an ordinary purchaser using a reasonable degree of care would distinguish between them without much effort: “The overall effect of the design with the oval below the seat, while certainly taking advantage of the graceful curves designed into the Patent design, creates a different and distinctive look that would not confuse the ordinary observer. Each of the individual ornamental elements may be almost identical in isolation, but the overall impression is aesthetically different.” Infringement exists only if the ordinary observer would take one product to be the other, and a site furnishings purchaser was not likely to be deceived into buying the Necati bench thinking it to be VSI’s bench. Indeed, Pappas was awarded a design patent for the Necati bench, indicating that the examiner reached the same conclusion.

VSI could recover defendants’ profits from the infringement, which the court set at a bit over $35,000, plus prejudgment interest. Like the state-law unfair competition award and the Lanham Act palming off award, this award was included within, and therefore duplicative of, the profits award for copyright infringement. VSI also got an injunction against further infringement of the Nebelli bench. VSI doesn’t license its designs; it sells the resulting products and relies on designs to distinguish itself as a leader.

VSI was also entitled to attorneys’ fees; for patent infringement, the standard is (1) clear and convincing evidence that the case is exceptional, and (2) a judicial determination that a fee award is appropriate. Litigation misconduct alone can make a case exceptional, as it was here. “Defendants' obstructive behavior delayed this litigation, drove up the costs for VSI, and needlessly taxed the Court's resources.” Various factors go into an appropriateness determination, including deliberate infringement; most of them weighed in favor of a fee award, such as “deliberate use of a false identity to download and then hand trace the VSI design.” On the other hand, the case was close enough to require an actual trial, and the court held one bench noninfringing. On balance, the court decided to award fees on the design patent claim.

Guesting at SCOTUSblog

With a recap of the oral argument in Golan v. Holder.

Willful blindness is fraud on the PTO

Sovereign Military Hospitaller Order of Saint John of Jerusalem of Rhodes and of Malta v. The Florida Priory of Knights Hospitallers of the Sovereign Order of St. John of Jerusalem, Knights of Malta, the Ecumenical Order, --- F. Supp. 2d ----, 2011 WL 4639824 (S.D. Fla.)

Plaintiff SMOM is a Catholic, non-profit international organization with associations in over 45 countries, including several in the United States. Defendant Florida Priory is a nonprofit, ecumenical Christian organization associated with an international ecumenical association known as Knights Hospitallers of the Sovereign Order of Saint John of Jerusalem, Knights of Malta, the Ecumenical Order ("Ecumenical Order"). SMOM sued for trademark infringement, false advertising, unfair competition and deceptive trade practices, while the Florida Priory counterclaimed for cancellation of several of SMOM’s federal trademark registrations.

The court dropped a footnote disparaging the parties’ charitable activities: “The amounts of money each party has raised for charitable purposes are unimpressive, which leads the Court to believe that the members of both SMOM and the Ecumenical Order are more interested in dressing up in costumes, conferring titles on each other and playing in a ‘weird world of princes and knights’ than in performing charitable acts.” Query whether this affects the result—would the court be more protective of a “real” charity with registered marks?

SMOM and the Florida Priory share a history going back to the late 11th century, “when a lay religious Order was founded in Jerusalem to run a hospice for Christian pilgrims.” It came under the aegis of the Catholic Church, performing both charitable and military functions. The Order went by names including "Knights Hospitaller"; the "Knights of St. John," referring to its patron saint John the Baptist; the "Knights of Jerusalem," referring to the location of the Order's founding; the "Knights of Rhodes," once it took possession of Rhodes in 1310; and the “Knights of Malta,” from 1530, when it received the island as part of a grant from Roman Emperor Charles V. “Napoleon drove the Order from Malta in 1798, after which the knights scattered, with some returning to their homelands and others relocating to Russia. The Order subsequently ceased all military functions and focused exclusively on charitable work.” It is at this point that the parties’ histories diverged.

As SMOM tells it, Czar Paul I of Russia allowed the establishment of a Catholic Order from which SMOM claims descent. The czar, who was Russian Orthodox, also created a non-Catholic Order and appointed himself Grand Master thereof. The Florida Priory claims descent from this Order. SMOM does not consider Czar Paul I a legitimate Grand Master because he was never confirmed by the Pope, was not Catholic, was not celibate, and had not been a member of SMOM for the required number of years. In 1810, Paul’s son Alexander took away both Orders’ lands.

The Russian Orders, with Orders in other European countries, elected a Grand Master in 1803. The Pope confirmed this election. In 1926, an American Association of SMOM was established in New York, followed by a Western Association in 1953 in San Francisco and a Federal Association in 1974 in Washington, D.C. SMOM registered a number of service marks involving its shield and cross symbol, KNIGHTS OF MALTA, SOVEREIGN MILITARY HOSPITALLER ORDER OF ST. JOHN OF JERUSALEM OF RHODES AND OF MALTA, and HOSPITALLERS OF ST. JOHN OF JERUSALEM, ORDER OF ST. JOHN OF JERUSALEM. SMOM also uses “an unregistered mark that consists of a crown atop an open, fur-lined mantle sable. An ordinary cross superimposed over a Maltese cross sits inside the mantle sable. A chain winds its way through the Maltese cross and encircles the ordinary cross.”

The Florida Priory said that, “after the 1798 expulsion from Malta, the knights scattered, with some returning to their homelands and some migrating to Russia. The knights who returned to their homelands established independent Orders according to their geopolitical locations and religious persuasions. Meanwhile in Russia, Czar Paul I established two priories of the Order, the Polish Grand Priory for Catholics and the Russian Grand Priory for Russian and Greek Orthodox individuals.” The Florida Priory claimed that the Russian knights elected Czar Paul I Grand Master and that the Pope confirmed this election, that Czar Alexander returned the Polish priory to the Pope, and that during this period, a number of Orders of St. John were formed across Eurasia, with each claiming ties to the original order. Today, the Florida Priory contended, there are more than ten such Orders.

In this version of events, the Russian Grand Priory continued in Russia until the Bolshevik revolution, at which time its headquarters moved from St. Petersburg to the United States. It held its first US meeting in 1908, claiming the title of Knights of the Sovereign Order of Saint John of Jerusalem, and also referring to itself as a Grand Priory of the Order of the Knights of Malta and the Sovereign Order of Saint John of Jerusalem. The Ecumenical Order incorporated as "The Knights of Malta, Inc." in New Jersey in 1911, changed its name to "Sovereign Order of St. John of Jerusalem" in 1953, and was succeeded in interest in 1956 by a Delaware corporation, the "Sovereign Order of Saint John of Jerusalem, Inc." In 1958, the Ecumenical Order registered SOVEREIGN ORDER OF SAINT JOHN OF JERUSALEM AND KNIGHTS OF MALTA. The Governor of Indiana issued proclamation in 1977 declaring a "Dedication Day" in recognition of the contributions of the Ecumenical Order. The Ecumenical Order has used its names in the US since 1911 and has associations and members in New Jersey, Pennsylvania, Delaware, Florida, Texas, North Carolina, South Carolina and Texas.

Disputes led the Ecumenical Order to sever ties with the group that controlled the Delaware corporation in 1981, and after that the Ecumenical Order operated as an unincorporated entity. Over time, the Russian Grand Priory came to be known as Knights Hospitallers of the Sovereign Order of Saint John of Jerusalem, Knights of Malta, the Ecumenical Order. The “Ecumenical Order” language was added in 2002 to distinguish the Ecumenical Order from SMOM. The Florida Priory was formed as early as 1992 and incorporated in Florida in 2005.

In 2008, the Ecumenical Order applied to register a US trademark in "[a] white cross on a red cross at the center of a red outlined Maltese Cross. A red crown is above the Cross," claiming first use in 1798 and first use in US commerce in 1916.

SMOM and the Ecumenical Order have interacted for a long time. In 1983, the Grand Chancellor of the Ecumenical Order sent a letter to SMOM seeking cooperation in an internal dispute involving the Ecumenical Order and a splinter group that obtained control over the Ecumenical Order’s US registration. The letter was sent on official letterhead bearing the marks "Sovereign Order of Saint John of Jerusalem" and "The Knights Hospitallers of the Sovereign Order of St. John of Jerusalem" and related to activities in the United States. This constituted notice of the use of those marks. SMOM also tried to cancel the registration, but withdrew its cancellation request with prejudice in 1987. There was plenty of other evidence of SMOM’s knowledge of the Ecumenical Order; SMOM mostly considered it a “false order” and, as one of its members wrote, “a modern invention, with no connections whatsoever, other than its assumed name, with the genuine Hospitaller Order founded in the Holy Land, whose only legitimate successor is [SMOM]." However, in 2000, Chancellor Prince Boudewijn de Merode of SMOM expressed the opinion that the Ecumenical Order may duly dub knights.

Despite all this, SMOM filed its applications in 2002/2003, including a declaration that no other person was entitled to use the applied-for marks in commerce for the relevant services. (The declarant testified that he’d never heard of the Ecumenical Order, and the court concluded that SMOM designated an individual with no personal knowledge of the Ecumenical Order to sign the applications.) The Examining Attorney had questions about the existence of many Orders of St. John. SMOM still didn’t disclose the existence of the Florida Priory or the Ecumenical Order and others that were using the same or similar names and marks. SMOM distinguished its trademarks from the Delaware corporation's registration and the marks of other Orders by arguing to the PTO that its work was charitable in nature, although it knew that the other Orders were charitable as well.

Three out of five of SMOM’s registrations are incontestable. SMOM also opposed the Ecumenical Order’s trademark application, which opposition has been stayed pending the outcome of the current court case.

After all this history, the court pointed out that it was not in the business of resolving religious or historical disputes about the identity of the “real” Knights of Malta.

The Florida Priory didn’t challenge SMOM’s registration for its cross and shield mark, but it did challenge the others on the ground that they were procured by fraud. Knowing misrepresentations to the PTO with the intent to deceive constitute fraud. Intent can be inferred from direct or circumstantial evidence. Although the individual who signed the applications testified that he had no knowledge of the Ecumenical Order or the Florida Priory, the declarations themselves averred false facts: that no other identity used the marks in question. “SMOM knew of the existence and domestic presence of the Ecumenical Order at the time it filed the trademark applications. Given that SMOM claims there is a likelihood of confusion with the Ecumenical Order, SMOM had a duty to disclose the existence of the Ecumenical Order to the PTO.”

Building off of Global-Tech Appliances, Inc. v. SEB S.A., 131 S.Ct. 2060 (2011), the court found that the appropriate standard is willful blindness as opposed to deliberate indifference: "a willfully blind defendant is one who takes deliberate actions to avoid confirming a high probability of wrongdoing and who can almost be said to have actually known the critical facts." SMOM had actual knowledge of the Ecumenical Order nearly two decades before it filed its applications. It then had an attorney with no personal knowledge of the Ecumenical Order execute the applications. SMOM’s failure to inform him is evidence of willful blindness. The court cancelled four of its registrations on that ground.

The court then turned to whether the Florida Priory’s unregistered symbol infringed SMOM’s registered symbol. Answer: no. The marks were easily distinguishable. SMOM’s registered mark consists of a Maltese cross on a shield, while the Florida Priory's mark consists of an ordinary cross on a shield. The shield is superimposed over a Maltese cross and crown sits atop the Maltese cross. The Florida Priory's two crosses to SMOM's one and addition of a crown serve to remove “any possibility for consumer confusion.” (Though the court doesn’t say so, the descriptiveness/prevalence of crosses in symbols for religious-affiliated entities, and the long period of coexistence, clearly bear on this determination.)

SMOM also had §43(a) claims based on an unregistered symbol, but the court decided to defer to the pending, stayed PTO opposition on the matter. (Can it do that? If the opposition was stayed pending this decision, isn’t it now in limbo? Also, given that an opposition doesn’t ask exactly the same questions as an infringement proceeding, I’m not sure there’s a legal basis for deferring to the PTO here.)

SMOM brought Lanham Act false advertising claims as well, arguing that the Florida Priory misappropriated SMOM’s history. No: “References by the Florida Priory to a shared history with SMOM are perfectly appropriate, as the organizations shared a history prior to 1798. Any claim for false advertising also rings hollow given that the Florida Priory expressly associates itself with the Ecumenical Order, a non-Catholic organization.”

This also doomed the coordinate state unfair competition claims. However, the fact that the court cancelled the federal registrations for SMOM’s word marks didn’t preclude a common-law unfair competition (trademark) claim based on those marks. (Or §43(a) claims, but SMOM apparently didn’t argue that, and no matter: the standard is the same.)

The court found no likely confusion because SMOM’s marks were weak and merely descriptive. “The marks consist of commonly used historical locations, religious terminology, and geographic terms that are not specifically associated with SMOM. As noted, the Ecumenical Order has been using these terms in the United States for over a century. The Court's own research indicates that there are numerous Orders that use this type of terminology in their names.” In addition, the Florida Priory clearly disclaimed affiliation with SMOM on its website. It shares a history with SMOM, “yet is a distinct entity and is ecumenical in nature as opposed to the exclusively Catholic SMOM.”

Unsurprisingly, there was also no violation of Florida’s consumer protection statute.

The court reserved judgment on whether this case was “exceptional,” allowing the Florida Priory to decide whether to submit a post-judgment motion for fees.

Organization for Transformative Works membership drive

As a former board member, current legal committee chair, and overall proud supporter of the OTW, I urge you to contribute. The Copyright Office just began the process for the next round of DMCA exemptions; the ones we fought for so hard will disappear unless we once again stand up for transformative uses. Your support helps the OTW protect and defend noncommercial fanworks.

It's a people's movement and an exam question

Links to apparently unauthorized reproduction of the complete first and second issues of The Occupied Wall Street Journal. Analyze the trademark and copyright issues!

Plaintiff without product in the market lacks standing

CareerFairs.com v. United Business Media LLC, 2011 WL 4527448 (S.D. Fla.)

CareerFairs.com’s basic claim was that UBM used CareerFairs.com’s idea for an online career fair interview format despite the execution of a confidentiality and non-compete agreement.

Among its claims was a Lanham Act false advertising claim, because it was unable to compete with the defendants in the university market because UBM falsely advertised that it originated the virtual career fair. Despite the apparent Dastar problem, the court instead focused on standing, the current path of least resistance, because plaintiff didn’t allege it had a competing product on the market. Using the Phoenix of Broward factors, plaintiff lacked standing. The Eleventh Circuit has rejected plaintiff’s argument, taken from the Ninth Circuit’s standard, that harm to “ability to compete” suffices (and anyway the Ninth Circuit requires actual or direct competition, which plaintiff didn’t allege). “[D]irect competition is essential to a finding of standing to bring a false advertising claim under the Lanham Act in the Eleventh Circuit.” (Note that this is a complete reversal of the idea motivating Conte Bros., the Third Circuit case whose test was adopted by Phoenix of Broward. In theory, the Conte Bros. approach potentially expanded standing beyond direct competitors with a multifactor test in which direct competition was not a necessary element. In practice, it’s used to deny standing to direct competitors, as this court also recognized.)

The Phoenix of Broward factors don’t expressly require the plaintiff to have a product in the market, but that’s indicative of direct competition. In Natural Answers, Inc. v. SmithKline Beecham Corp., 529 F.3d 1325 (11th Cir. 2008), the court held that a plaintiff that had ceased selling its product seven months before the defendant's launch of its own competing product “did not qualify as a direct competitor and was therefore unable to satisfy any of the five Phoenix Factors.” The Lanham Act false advertising claim was dismissed with prejudice.

Claims for misappropriation of business idea and trade secrets, and a resulting Florida Deceptive and Unfair Trade Practices Act (FDUTPA) claim, did survive. Even though plaintiff isn’t a consumer, the statute is designed to protect legitimate businesses from unfair competition and deceptive acts (here misappropriation).

Misallocation of damages has tax consequences

Healthpoint, Ltd. v. Commissioner, T.C. Memo. 2011-241, 2011 WL 4550112 (U.S. Tax Ct.)

I don’t think I’ve ever blogged a tax case before, but this involved the proceeds of a settlement agreement in a false advertising case. Healthpoint is a specialty pharmaco which sold, among other things, a successful prescription ointment called Accuzyme. Ethex introduced Ethezyme, marketed as a generic form of Accuzyme, but with an additional potentially harmful chemical and more active ingredient. This caused Healthpoint economic damage, and it sued for false advertising, unfair competition, and related claims. Actually, it sued twice, for new claims about a new formulation of Ethezyme that came too late to add to the older case.

The jury in the first case ruled for Healthpoint, finding false advertising and additionally finding that Ethex acted with malice under Texas law, though rejecting claims that Ethex had knowingly or intentionally diluted Healthpoint's trademark or disparaged Healthpoint's business. The jury awarded over $16 million, $5 million in actual damages, over $1.6 million in disgorgement of profits, over $3.1 million in punitive damages, and over $6.3 million in enhanced damages under the Lanham Act.

In the end, the parties settled the first case for $12 million and the second for $4.5 million. The parties agreed to a nondisparagement clause that permitted Healthpoint to use public domain documents to promote Accuzyme and distinguish it from Ethezyme, coupled with terms that prohibited Ethex from using the settlement agreement for those same purposes. Ethex proposed allocating $12 million to "compensatory damages arising out of alleged unintentional product disparagement" to settle Ethex I and $4.5 million with the same description to settle Ethex II.

Healthpoint’s tax counsel prepared an outline of the categories of damages, but didn’t assign amounts; Healthpoint then proposed a different allocation. Ethex refused to settle with any public statement “that might be associated with willful misconduct. We feel strongly that this characterization of our conduct is completely unjustified. These accusations have been injurious to our reputation, and we will not do anything that might be interpreted as conceding that we acted in a knowing manner.” Healthpoint subsequently acquiesced to Ethex's demand to eliminate allocations to misappropriation and punitive damages.

The ultimate agreement allocated damages in Ethex I of $10.45 million to damage to goodwill and reputation, and $1.35 million to lost profits/disgorgement. The corresponding figures for Ethex II were $4.05 million/$450,000. The settlement agreement also included the statement that "no part of the sums paid pursuant to this Agreement are for willful misconduct" or for punitive damages. There was also a nondisparagement clause that allowed Healthpoint to use publicly available documents from the lawsuit to distinguish the parties’ products.

Healthpoint didn’t have any business documentation of the goodwill or make any calculations during settlement negotiations to justify the allocations. It was aware of the potential tax benefits of characterizing money as capital gain, but its tax counsel wasn’t involved in the allocation.

Healthpoint reported $14.5 million in long-term capital gains from the settlement and $1.8 million in ordinary income. The IRS disagreed, though eventually conceded that the over $6.3 million in enhanced Lanham Act damages awarded by the jury in Ethex I were taxable as long-term capital gains.

Healthpoint argued that the IRS should respect the allocations made in the settlement agreement. Proceeds for goodwill or damage to reputation are taxable as capital gain, while proceeds determined to be lost or disgorged profits or punitive damages are taxable as ordinary income. The rule is that the tax consequences of damages received under a settlement depend on the nature of the claim that was the basis for the settlement, not the validity of the claim. An express allocation in the settlement agreement is generally followed if it was entered into at arm’s length and in good faith, but isn’t determinative if other facts indicate that the payments were for a different purpose.

In particular, the fact that a defendant didn’t desire to admit that it was paying punitive damages isn’t dispositive where there’s solid evidence that the prospect of punitive damages increased the amount the defendant paid in settlement. Though the parties were generally adverse, if they ultimately allocated the funds in a way that did not represent the claims they actually intended to settle, then the tax treatment need not respect the allocations made in the settlement agreement.

Here, Ethex refused to pay any amount labeled as punitive damages, but it still paid a negotiated sum. “Ethex was indifferent as to how Healthpoint chose to allocate the funds so long as the allocation did not imply intentional wrongdoing, and it permitted Healthpoint to assign the same amount of damages to any other category.” Thus, the allocations weren’t the product of negotiations between adverse parties. Healthpoint was aware that the proposed allocations would result in a more favorable tax rate, and the tax benefits were of more value to it than being able to tout that it had received punitive damages under the nondisparagement agreement. It proposed an allocation to punitive damages that was significantly less than the amount of the jury award, suggesting that tax considerations were foremost.

A jury verdict is the best indicator of the worth of a plaintiff’s claims, so, in light of the facts, the allocations made by the jury in Ethex I should be applied to that part of the settlement. There was never a jury verdict in Ethex II, though. But because the cases were very similar, and the settlement agreement allocated the damages in similar proportions, damages should be allocated in the same proportions.

This result also triggered an accuracy-related penalty for Healthpoint.

So, practice tip: consider the tax consequences of settlement—but have non-tax-related reasons for making the allocations you make!

Elf defense: parody defeats TM and copyright claims

CCA and B, LLC v. F W Media Inc., --- F.Supp.2d ----, 2011 WL 4583790 (N.D.Ga.)

Plaintiff sells The Elf on the Shelf, and defendant is about to sell The Elf off the Shelf, a self-described parody. Plaintiff sued for trademark infringement and dilution, copyright infringement, violation of ACPA, and coordinate state claims, but it sought a preliminary injunction only on the trademark and copyright infringement claims.

Elf On (yes, that’s the court’s shorthand) is “a popular children's Christmas book sold in a 10" by 10" by 2.5" box set with a plush toy elf doll 8.5 inches in height in a red costume.” It’s sold more than 1.5 million copies since 2005. Plaintiff registered copyrights in the elf doll and the sitting elf image on the cover. It also registered trademarks in the word mark "The Elf on the Shelf," the stylized logo used on the cover of its book, and the sitting elf image and operates www.elfontheshelf.com to promote its book.

Elf On “explains how Santa keeps track of who's naughty and nice each year and what are their wishes: by employing millions of "scout" elves around the world to monitor children's behavior. These friendly elves are dispatched to individual families to watch the children's behavior and report nightly back to Santa. The story warns children that the elf will report every "push or a shove" or broken rule, but reassures that ‘small acts of kindness will not be a loss.’ The elf encourages children to tell him their every gift desire so he can report their lists to Santa.” The illustrations are “subdued watercolor paintings that resemble the world of a child's imagination more than that of reality.”

Plaintiff encourages parents to move the elf around the house each day “as evidence that the elf returns to the North Pole at night to tell Santa about their behavior,” and the book jacket said that the author discovered that this tradition helped children control themselves with “a gentle reminder that ‘the elf is watching.’”

Elf Off (yep) “tells a very different but related story. The elf narrator describes himself as a discount elf (sprung from a marked-down copy of Elf On) who is supposed to help Santa decide who's been naughty and nice. But the stories quickly diverge from this common ground. In Elf Off, the elf warns that he'll be ‘pissed’ if children give him a name he dislikes.… [Horace the Elf is] going to drink spiked eggnog, try to make his ‘move’ on Barbie while Ken's away at the Malibu dream house, watch pornography in the middle of the night, change the children's gift list so there's ‘something in it for me,’ and finally, run away to the tropics rather than return to the North Pole.”

The book jacket says that, prior to "being sent out to spy on and judge small children, [Horace] worked the assembly line in Santa's Workshop." Elf Off’s cover includes the book title in a font that is quite similar to plaintiff's stylized logo font, an image of an elf in a green costume dangling from a shelf, the subtitle "A Christmas Tradition Gone Bad," a byline attributing the story to Horace the Elf, and a final sentence, in red font: "A new holiday parody--for Mom and Dad!" The book is much thinner than plaintiff’s box set and doesn’t come with a doll or special packaging. The back cover “shows a photograph of the elf doll holding the Elf On book while surrounded by a remote control, Zombie Slayer DVD, and various gift cards” and also has a small-print disclaimer.

Elf Off is illustrated of photos of the Elf On doll in a green costume. “Photographs show the elf splayed on a table with spilled eggnog, snuggled in bed with Barbie, hanging out in the Christmas tree with a nutcracker, and lying behind a toilet after being tormented by the cat. The first page of the Elf Off story shows a small picture of Plaintiff's book, including the sitting elf image, partially obscured by ‘75% off’ and ‘super markdown’ stickers.” Defendant operates www.elfofftheshelf.com.

Plaintiff argued that defendant’s book undermines Elf On’s “wholesome and healthy” brand image, citing an article in Publisher's Weekly that reported that Elf Off is intended to "knock a holiday favorite off its perch." Defendant agreed, but said that that was a perfectly acceptable parodic goal.

Plaintiff alleged that defendant’s photos of the elf doll infringed its copyright in the elf doll, and that defendant’s use of the dangling elf and photos of plaintiff’s book infringed its copyright in the sitting elf image. In addition, plaintiff alleged that its trademarks in the book title, domain name, stylized word mark, and sitting elf image were infringed by the corresponding uses by defendant.

The court first asked whether Elf Off was a parody. Because we can’t let a question like that be simple in IP, the inquiries are similar, but not identical, for trademark and copyright. For copyright we look for comment on or critique of the original, and for trademark we look for whether the use is “clearly in jest.”

Copyright: the parody is clear,

albeit not particularly pungent. The question is simply whether a parody may reasonably be perceived in the content. borrows Elf On's elf-spy idea to tell the story of a very naughty elf with little interest in monitoring children's behavior. Elf Off may not render a scathing critique of Plaintiff's book, but by reporting his own mischief throughout the story, Horace highlights the perceived absurdity of a “big brother” type of elf reporting on small children in Elf On. The odd realism in Elf Off (with images, including the unflattering photograph of the elf doll lying next to a toilet, suggestive of an under-employed adult living with his parents) contrasts with the wonderland world of Elf On in a way that makes the idea of using an Elf "scout" (or spy) to encourage good behavior in one's children seem somehow unsavory. Horace is not hilarious, but he does use his foul mouth to say something pointedly different than the elf in Plaintiff's work.

But there’s conceptual trouble in parodyland—plaintiff wasn’t arguing that defendant’s book infringed plaintiff’s book, rather that defendant’s book infringed the elf doll and sitting elf image. (Side note: I question whether the sitting elf and dangling elf images are substantially similar.) Puzzlingly, the court found this distinction “relevant” but still concluded that the use was “in the context of a parody” and, without further analysis, found that there was comment or criticism of “the copyrighted work.” It would have been better, I think, to reject plaintiff’s attempt to divide up its interests in this way; there’s always some element of the original that isn’t itself transformed or criticized in a parody, but the question should be whether there is transformation overall, and the court functionally reaches this result, just adding in some awkward somersaults along the way.

Because Elf Off was itself the product being sold rather than an ad, its commercial purpose weighed only somewhat against fair use. Plus, it was transformative; where plaintiffs want parents to create the impression that the doll has a magical life of its own, defendant “depicts the doll in rather unromantic settings that similarly demystify the magical idea of the elf doll in Elf On.” The use of the sitting elf image in a photo of what looks like plaintiff’s book, that use furthers the attack “by showing the book covered with clearance stickers and next to a Zombie Slayer DVD.” This use was also very small “and primarily provides a distinguishing reference to the original,” and could thus be considered inconsequential.

As for the dangling elf image, it didn’t do much to advance defendant’s story or convey commentary, so it wasn’t as transformative as the photos of the elf, but it was still in the context of a parody and therefore transformative. Overall, factor one pointed towards fair use.

Plaintiff’s work was creative, but this factor is neutral in parody cases. Likewise, parodies may need to take the heart of the original. The elf doll and the sitting elf image are the heart of Elf On—but plaintiff argued that it was claiming infringement of the doll and the sitting elf image, not the book. Thus, defendant copied the entirety of those works. But, the court reasoned, those images make up only a small proportion of Elf Off. In Mattel, Inc. v. Walking Mountain Prods., 353 F.3d 792 (9th Cir. 2003), the court pointed out that it’s hard to use only a portion of a doll, and that adding material assists the defendant in such a case by creating a context around the copied material. The amount and substantiality copied was therefore reasonable.
Effect on the market: plaintiff failed to explain its theory of market harm. Here the slice-and-dice approach backfired: “Nothing in the record indicates the elf doll or sitting elf image, independent from the book, have any market value whatsoever.” The court found it unlikely that defendant’s book of photos of the elf doll would replace sales of the doll or the sitting elf image. Instead, plaintiff argued that Elf Off would degrade the market value of Elf On. “The flaw in this argument is that Plaintiff has not alleged infringement of the story contained in Elf On.” And anyway, it was unlikely that consumers would choose this inappropriate-for-children parody in place of the wholesome Elf On. Defendant’s hope to knock a holiday favorite off its perch was legitimate harm done by parody, not illegitimate replacement. Plaintiff was conflating trademark and copyright.

Thus, there was no likely success on the merits of the copyright claim.

Trademark: a trademark parody has to be successful in communicating both the reference to the original and some kind of ridicule of it. The court found that the differences between the works would be most clear side-by-side, but consumers might not view the products that way. The font and design are nearly identical, so a consumer might not immediately identify the parody; the dangling elf was a “subtle” alteration of the sitting elf. The difference between off and on and the different color schemes were also minor. But the subtitles "a new holiday parody--for Mom and Dad," “clearly provide additional cues that distinguish the marks.”

Citing the old Fourth Circuit PETA case, plaintiff argued that the court should only look at the cover and the domain names at issue, but as that court clarified/retreated in Lamparello v. Falwell, 420 F.3d 309 (4th Cir. 2005), context is highly relevant. Though this was a close question for trademark purposes looking just at the covers, the boldface parody statement plus the disclaimers on the back and inside pages, and multiple other visual cues were enough to change the overall impact “to present enough visual information to flag for consumers that the book is a parody for adults.” Likewise, the Elf Off website “presents the book cover immediately on arrival at the site and thus similarly communicates that the book and website parody the original.”

In a footnote, the court suggested ways that defendant could have done a better job of conveying its parodic purpose, and cautioned that “the facts at this early stage of the case do suggest an arguable possibility of consumer confusion. Plaintiff potentially could present survey evidence proving consumer confusion at trial. In light of this, Defendant may wish to consider taking additional measures to distinguish the cover of Elf Off before marketing it.” This highlights the ways in which trademark can underprotect expressive uses: I have no doubt that plaintiffs could, for enough money, get a survey suggesting likely confusion. But I don’t think the game is worth the candle.

On to infringement: for purposes of this motion, the parties agreed that the marks were strong and that Elf Off used similar marks. In the Eleventh Circuit, parody is not itself a defense but influences the way the likely confusion factors are applied. The court treated the Elf Off book title and the Elf Off domain name the same because the website prominently displays the book cover.

Mark strength may reduce the likelihood of confusion in a parody case, because consumers are more likely to get the joke. Here, though the parties agreed that the marks were strong, the court was still uncertain about distinctiveness. “The use of an elf in a Christmas-theme gift set is not a unique idea. At best, Elf On is well known within a particular sub-set of the population.” Then, though, the court pointed out that the sub-set comprised both parties’ target audience. Assuming the mark is strong, this factor favored the defendant.

Similarity: did defendant borrow so much that its use became ineffective as parody and instead seemed to be affiliated with or sponsored by plaintiff? The court found that the sight and sound were extremely similar, but somewhat more risk of confusion should be tolerated in cases of parodic artistic expression. “Although at first glance consumers might not notice all the distinctions between the two products, the first glance is not decisive.” Momentary confusion can be tolerated when it would be readily dispelled by further consideration by an ordinarily prudent consumer. “Reasonable consumers faced with purchasing a children's book are likely to open the book to see what they are buying for their children.” Examination of defendant’s book would reveal the “parody” designation, and on any given page consumers would likely see that this wasn’t a children’s book. “They may see the bizarre rhymes about ‘that stupid toy train’ or Barbie being a prude. They may notice the photographs of an elf watching x-rated videos like ‘Elves Gone WILD.’ These multiple distinctions go far to dispel consumer confusion.… Consumers, particularly those buying books, are likely to notice significant literary distinctions.” So similarity of marks also favored defendant.

Similarity of products: they’re both books; the addition of the toy doll isn’t very significant. However, if differences in the marks indicate parody, then a use on an identical product can be noninfringing. “Because some amount of similarity is required to accomplish the parody, it is difficult to imagine how Defendant could have created its parody without a book, although this book need not have been identical in length and width dimensions or "first glance" presentation as Elf On. Defendant notably did not include an elf doll, which suggests this factor weighs only slightly in favor of Plaintiff.”

Sales channels/customers: Defendant planned to market its book using the same major retail outlets, including Amazon.com and Barnes & Noble. It targeted an adult audience, but both children and adults buy Elf On. “However, the Court finds that parents are usually the purchasers even when the target audience for a book is children, so the argument that child consumers will be confused is not persuasive.” The overlap in target market and sales channels favored plaintiff. Similarity in advertising methods was neutral at this stage—it was unclear whether defendant was trying to make its product or website show up in searches for Elf On. (Why would this increase confusion any more than negative reviews or other competing products showing up?)

Intent: Defendant’s criticism of plaintiff’s book plus its clear disclaimer weighed in its favor.

Actual confusion: There was no evidence of actual confusion, which is frequently key in parody cases. At this stage, though, the absence of evidence was just neutral.

Overall, while parodies may be confusing, that’s usually because they lack expressive elements or clear indications of parody. “Where some aspect of the work clearly communicates to consumers that it is a parody, or where the medium in which the marks are used is inherently expressive (such as artistic photographs), courts protect that expression.” Especially given the First Amendment concerns at issue, the factors weighed against finding likely confusion.

Without likely success, there wasn’t going to be a preliminary injunction. The court also pointed out that an injunction would destroy defendant’s plan to market Elf Off for the 2011 holiday season and take advantage “of a growing trend of made-for-adult parodies of children's books, a fad that may end before a trial on the merits is completed.” Plus, the public interest favors free speech.

Trademark expo Oct. 14-15

The PTO's announcement of this free two-day event is on its website. Were it not for my full-day commitment to AALS on both days I would love to go to see what exactly this entails, but the PTO says that the expo "is designed to educate the public about the value of trademarks in the global marketplace":

The Expo will highlight such themes as “Unusual Trademarks” and “Brand Evolution,” and will feature educational workshops for adults and children, exhibits of authentic and counterfeit goods, and costumed characters.

The opening ceremony on October 14, 2011 at 10 a.m. will feature music by the U.S Air Force’s rock band, Max Impact, and a guest appearance by Chubby Checker.

Click fraud securities case revived

FindWhat Investor Group v. FindWhat.com, -- F.3d --, 2011 WL 4506180 (11th Cir.)

Eric Goldman pointed me to this securities fraud case, of possible interest because it involves advertising-related claims. The investors sued defendant MIVA (aka FindWhat.com) and some principal officers for eleven false or misleading statements to the public, in violation of § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The statements allegedly artificially inflated the price of MIVA’s stock until the truth came out, at which point the stock dropped and plaintiffs lost money.

The district court rejected all the claims, nine on the pleadings and two on summary judgment on the grounds that plaintiffs failed to show loss causation and damages. Plaintiffs appealed on two of the claims dismissed on the pleadings and on the claims on which summary judgment was granted.

The court of appeals affirmed on the first set and reversed on the second. Basically, earlier false statements weren't actionable, but later ones that perpetuated the falsehood were actionable for sustaining the stock price longer than it would have had the truth come out earlier.

MIVA provides pay-per-click ad services, putting ads on its distribution partners/affiliates’ websites. MIVA shares a portion of its ad revenue with its affiliates. MIVA uses keyword targeting; advertisers bid for a position in search results. MIVA’s revenue is determined by advertisers’ bidding price and the number of clicks MIVA generates. Bidding price itself depends on the conversion rate from clicks to sales.

Because of the pay-for-click arrangement, click fraud (clicking on ads just to get the advertiser to pay) can be very costly. Click fraud can come through automated or human intervention; it results in lower conversion rates because the source of the click is uninterested in purchase.

According to the complaint, in 2003 two of MIVA’s top revenue-generating partners, Saveli and Dmitri, who together accounted for almost 1/3 of MIVA’s revenue from 2003-2005, began using automated click fraud to generate revenue. “According to a former Business Development Manager at MIVA, Saveli and Dmitri were ‘turn and burn guys’ who focused primarily on driving in a lot of traffic, regardless of its quality.” (One thing advertising folks may find notable in securities cases these days is that, because of heightened pleading requirements and judicial hostility to such cases, the average securities fraud pleading is likely to have a lot of detail acquired from independent investigations, usually relying on informants with inside knowledge of the defendant’s operation—by contrast, in an advertising case the plaintiff may have a lot of knowledge of the parties’ products or services, but is less likely to be able to plead about the defendant’s internal operations with specificity.)

The resulting low-quality traffic caused advertisers to lower their bids, decreasing MIVA’s revenue. A former account manager described the result as “serious, serious bid deflation.” Revenue per click dropped from $0.20-$0.21 in early 2003 to $0.12 by June 2005. This had a domino effect, driving away high-quality distribution partners. In a downward spiral, plaintiffs alleged, MIVA increasingly relied on “greedy and unscrupulous distribution partners who were focused on only short-term gain.”

Thus, by summer 2005, MIVA’s “supposedly extensive and diversified partner network had shrunk, with 95 percent of the Company's click revenue coming from its top fifty distribution partners—the top two being Saveli and Dmitri.” The network, according to a former marketing manager, was now best described as a "house of cards ... held together by a thread."

The short-term gains from click fraud allegedly enabled MIVA to report an uninterrupted string of quarter-by-quarter financial gains, meeting or exceeding analyst growth expectations in every single quarter since 2003. “Perhaps demonstrating the Company's obsession with meeting Wall Street's forecasts, these expectations were sometimes met by as little as a penny.” (Maybe I don’t read about them, but are there any nonfraudulent companies that can do this for a multiyear period? Either analysts are just terrible, in which case I don’t get why people rely on them, or their projections exert pressure to commit fraud in a short-term-focused company and the market might want to apply a discount to exceeding expectations at least as much as it punishes falling short of them.) “Between 2003 and 2005, the Defendants issued public statements reporting seemingly unstoppable growth stemming from its primary pay-per-click business.”

Thus, plaintiffs alleged, that despite MIVA’s actual bid deflation, defendants allowed click fraud to continue to meet growth expectations at the expense of the company’s long-term health.

Meanwhile, during 2004 and 2005, regulatory scrutiny of click fraud intensified. “In an effort to lull investors and advertisers into believing that the Company was proactive and aggressive about policing click fraud, Defendant CEO Pisaris-Henderson claimed during a Company conference call on February 23, 2005 that, in the fourth quarter of 2004, the Company had voluntarily removed distribution partners representing $70,000 in revenue per day because ‘our focus is to deliver traffic that converts rather than just clicks alone.’” However, according to the Senior Director of Business Development responsible for the oversight and management of all of MIVA's affiliates, “no traffic was taken off line in the fourth quarter of 2004.” This senior director said that the February announcement clearly referred to Saveli and Dmitri, because that’s what they earned in a day, but they weren’t removed from the network. A former marketing manager said that it was "an open secret within the Company that Dmitri and Saveli were not taken off line in December 2004, and neither was anyone else."

On March 16, 2005, in its Form 10-K annual report to the SEC, defendants repeated their claim that in the "fourth quarter of 2004, we ceased displaying advertisements with distribution partners ... whose traffic did not adequately convert to revenue for our advertisers," and that "the removal of these distribution partners reduced our average click-through revenue by approximately $70,000 per day," in conformity with its "long-stated goal of [providing] high quality traffic to our advertisers.” Miva also stated that "[w]e do not rely on 'spyware' for any purpose and it is not part of our product offerings," that "[w]e have implemented screening policies and procedures to .... detect[ ] fraudulent click-throughs, which are not billed to our advertisers," and that "[w]e have developed automated proprietary screening applications and procedures to minimize the effects of ... fraudulent clicks."

Before the Nasdaq opened on May 5, 2005, MIVA issued a press release announcing disappointing first quarter 2005 results and the resignation of Brenda Agius as CFO. Later that day, defendants CEO Craig Pisaris-Henderson and COO Phillip Thune revealed to the public that click fraud had indeed been responsible for some of the Company's revenues, stating in a conference call with analysts and investors that "a couple" of MIVA's distribution partners had been employing "capabilities ... to get additional traffic that just simply don't adhere to our standards." That day, MIVA's share price plummeted over 21 percent from the previous day, from $6.16 to $4.83, and continued to drop for the next few trading days, closing at $4.46 on May 9, 2005.

The court of appeals first addressed statements made on March 5, 2004 and July 26, 2004. The first was properly dismissed because plaintiffs failed to plead scienter with the requisite specificity and the second because the plaintiffs failed to allege falsity or misleadingness.

To survive a motion to dismiss, a 10b-5 claim must satisfy both Rule 9(b) and the additional pleading requirements of the PSLRA. For claims based on false/misleading statements, “the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." If scienter is required, "the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."

As to the insufficient claims: One stemmed from MIVA’s March 5, 2004 10-K, which said, “The FindWhat.com Network is dedicated to delivering high-quality keyword ads as a result of an Internet user's search query. As such, we have written and strictly enforce advertising guidelines to try to ensure high relevancy standards.” It continued, “We employ an integrated system of numerous automated and human processes that continually monitor traffic quality, often eliminating any charges for low quality traffic proactively from the advertisers' accounts. We enforce strict guidelines with our Network partners to ensure the quality of traffic on the system.” It also stated that it “expect[ed]” that its business partners would behave lawfully and ethically.

The district court found that these statements weren’t misleading because MIVA wasn’t warranting that it lacked current questionable associations, and that a “dedication” to high-quality traffic wasn’t inconsistent with the existence of low-quality traffic. Moreover, the Form 10-K was mostly forward-looking statements that were appropriately accompanied by cautionary statements.

The court of appeals disagreed about whether this could be materially misleading. There were statements of present fact about MIVA’s “integrated system ... that continually monitor[s] traffic quality," and claims that "[w]e enforce strict guidelines ... to ensure the quality of traffic," which “unquestionably create the impression that MIVA maintains an active and sophisticated monitoring system for screening fraudulent traffic.” These statements could have misled a reasonable investor. Assuming the truth of the other facts alleged, these statements triggered a duty to disclose the system’s grave defects, and the failure to disclose wasn’t cured by any general cautionary or risk-disclosing language, since MIVA offered only general warnings about risks inherent to its business model, not specifically tailored to risks from click fraud. It would be deceptive to withhold information about actual known breaches of click-fraud monitoring systems already touted in the 10-K.

However, the court of appeals still affirmed because plaintiffs failed to plead scienter adequately. What was required was intent to defraud or severe recklessness, meaning highly unreasonable omissions or misrepresentations involving an extreme departure from the standards of ordinary care that present a danger of misleading others that is either known to the defendant or that is so obvious that the defendant must have known of it. The PSLRA requires that the complaint’s allegations create “a strong inference” of scienter, meaning that the inference must be more than plausible or reasonable. It must be at least as compelling as any alternative inference of nonfraudulent intent. Each act or omission must be evaluated separately and for each defendant, though the court’s inquiry must be holistic (it need not ignore the other acts or omissions when evaluating each one individually).

Essentially, plaintiffs didn't plead enough specifics to generate a strong inference of scienter until mid-2004 at the earliest, when there was a meeting to discuss terminating Saveli and Dmitri. This put the earlier statements off-limits. Defendants’ motives to meet Wall Street revenue expectations were insufficient to establish scienter—mere motive and opportunity is insufficient. (It’s tough out there for a securities plaintiff.)

On to the July 26, 2004 public conference call discussing second-quarter results. Defendant Thune, the COO, said that revenue was increasing by June and that “we believe that every one of our divisions can grow revenue from Q2 to Q3, despite the seasonal softness typical in the summer months, when individual Internet usage usually declines.” The future performance statement was non-actionable, and plaintiffs didn’t allege that revenue was not increasing by June.

Plaintiffs argued that this was misleading because the growth came from click fraud, and that by making affirmative claims MIVA had a duty to disclose other facts necessary to avoid an incomplete and misleading picture. However, a company has a duty to disclose only when the natural and normal implication of its statements would be misleading. Thune’s statement would be misleading only if it conveyed a false impression of the quality of MIVA’s click traffic. But a statement about total revenue, which also included MIVA’s recently acquired companies, conveyed no such message. It’s generally okay to tout past success, even if future prospects are less rosy.

On to the remaining two statements from 2005 (detailed above), the issue was whether plaintiffs’ expert report demonstrated genuine issues of material fact on loss causation and damages. The district court held that there were no triable issues of fact because the expert acknowledged that MIVA’s stock price was inflated by 26.44% before the first actionable misrepresentation and remained inflated after. The district court reasoned that because the stock price didn’t change, the otherwise actionable statements couldn’t have caused the plaintiffs’ losses.

This was error. Investors who purchased at inflated prices after the fraudulent statements were made may have sustained substantial losses they wouldn’t have suffered had the defendants revealed the truth at the start of the class period.

Fraud-on-the-market theory hypothesizes that disclosure of confirmatory information--information already known by the market--will not cause a change in the stock price. But publicly disseminated falsehoods will artificially inflate the stock price as long as they remain uncorrected, tainting the total mix of information. When the misinformation is corrected, the market will dissipate the artificial inflation.

Loss causation can frequently be shown circumstantially, when plaintiffs identify (1) a corrective disclosure, (2) a price drop soon thereafter, and (3) an absence of other possible explanations for the price drop. Plaintiffs’ expert report, which the district court assumed was admissible for purposes of the summary judgment motion, offered evidentiary support for both loss causation and damages. The expert conducted an event study, common in such cases, estimating the damages at $22.24 million.

The district court ruled that the inflation preexisted the actionable fraudulent statements, rendering the expert report irrelevant. The court of appeals held that this was a misapprehension of the nature of market fraud. “Inflation creates an ongoing risk of harm. Every investor who purchases at an inflated price--whether at the beginning, middle, or end of the inflationary period--is at risk of losing the inflationary component of his investment when the truth underlying the misrepresentation comes to light.”

Investors who buy and sell during the inflationary period overpaid, but they can recoup by selling at the same inflated price. But investors who buy at inflated prices and hold will suffer economic loss. “Because thousands of shares of stock are purchased each day, the longer that inflation remains within a stock price, the more shares that are purchased at inflated prices, and the more shares that stand to lose when the inflation subsequently dissipates from the price. Clearly then, a falsehood that endures within the marketplace for a longer period of time, all else being equal, will cause greater harm than one that endures for a shorter period of time.”

In conclusion, the court of appeals declined “to erect a per se rule that, once a market is already misinformed about a particular truth, corporations are free to knowingly and intentionally reinforce material misconceptions by repeating falsehoods with impunity.” So, even if the earlier nonactionable statements started the trouble, as long as the market believed that defendants had click fraud under control, the later false statements could cause continuing harm.

Another penny auction site faces consumer claims

Parino v. BidRack, Inc., 2011 WL 4479462 (N.D. Cal.)

Parino, putative class representation, alleged that BidRack owns and operates bidrack.com, a penny auction site. Allegedly, BidRack attracts consumers via "a series of sponsored advertisements and fake news stories," which "overtly misrepresent the services and products offered by BidRack." The homepage "heavily emphasizes that registration is 'completely FREE!' " and "free" is frequently repeated on the site. The site also contains fake news stories, endorsements, and consumer testimonials. During “free” registration, customers are sent to a page with "a cluttered assortment of boxes, graphs, arrows, bright colors, charts, logos, and numbers" and are directed to enter shipping and credit card information "to pay for items, shipping, or bids when they choose to buy them." Instead of requiring explicit acknowledgement of a credit card charge, the customer simply clicks a button labeled "START WINNING" to complete registration.

Parino allegedly incurred an unwanted charge to buy a “bid pack,” after she’d viewed and relied on ads on the site including videos of purported news programs and "alleged endorsements of BidRack.com that appeared next to logos for organizations such as the New York Times and BBC." She alleged that she did not see any statements on the website that her credit card would be charged, but she was charged $99. When she discovered this, she contacted customer service to dispute the charge, to no avail. She also contacted her credit card company, which also did not give her a refund.

She alleged violations of California’s FAL, CLRA, and UCL, as well as fraud in the inducement, breach of contract, and related claims. BidRack moved to dismiss for failure to satisfy Rule 9(b). The court noted that some of her claims were subject to 9(b) and some weren’t.

Parino pled sufficient facts to state a claim under the FAL and UCL. The allegedly false and misleading statements included that registration was free, that supposed reviews from satisfied customers were actually created by defendants, and that BidRack was affiliated with respectable news outlets such as the NYT, legitimizing the website. Parino pled knowing falsity because defendants allegedly were the ones who faked the endorsements. For 9(b) purposes, she alleged enough the who (BidRack), what ("free"), where (BidRack.com), when (May 20, 2011), and how ("free" repeated numerous times in tandem with the call to register).

The CLRA separately prohibits misrepresenting the “source, sponsorship, approval, or certification of goods or services” and misrepresenting the “affiliation, connection, or association with, or certification by, another,” along with advertising goods or services “with intent not to sell them as advertised.” (As a matter of TM law, I don’t think that running actual clips from the NYT suggests any affiliation etc. with the NYT, so I’d want to be careful with this claim, but at the same time I do think there can be false endorsements in this situation, and if the defendants did fake stories that suggested that the NYT had found BidRack to be a legitimate site that should be actionable, if not by the NYT then by deceived consumers.) The same allegations of false and deceptive advertising, misrepresentation of the cost of registering with BidRack, and use of false news stories and endorsements leading Parino to believe the site was safe to register with for free stated a CLRA claim.

Fraud in the inducement exists when the promisor knows what she’s signing but her consent is induced by fraud, which itself requires (a) a misrepresentation (false representation, concealment, or nondisclosure); (b) scienter or knowledge of its falsity; (c) intent to induce reliance; (d) justifiable reliance; and (e) resulting damage. This too was sufficiently alleged under 9(b). BidRack knew that its claim of free registration was untrue because it was the one charging customers for registrations. Moreover, Parino’s reliance on the representations about free registration was justifiable, especially in light of the allegedly fraudulent news stories and endorsements lending BidRack credibility. Her claims for conspiracy to commit fraud in the inducement with an unknown John Doe marketer weren’t sufficient enough, though.

She did state a breach of contract claim, where the contract was that she’d get free registration. Her allegation of unjust enrichment, available only where there is no contract or where a contract was procured by fraud or is unenforceable, was properly pled in the alternative. Nor were her claims barred by the voluntary payment doctrine, which applies when a plaintiff voluntarily paid money with full knowledge of the facts. BidRack argued that Parino knew the facts once she saw her credit card statement, and that once she paid her bill she shouldn’t be able to recover. The cases BidRack cited were easily distinguishable because they involved disputes that only arose after plaintiffs made multiple payments over a long period of time.

Here, Parino disputed the charge immediately after she noticed it and requested a refund from BidRack, putting it on notice of her claim. Even if she paid her credit card bill, “payment to her credit card company so that she could stay in good standing with creditors while pursuing this action would not bar her claim.”

BidRack’s objections to the class allegations were not well taken at this point and should wait for the class certification stage.

Policy on accepting transgenic grain isn't commercial speech

Syngenta Seeds, Inc. v. Bunge North America, Inc., 2011 WL 4478510 (N.D. Iowa)

As is so often the case, this Lanham Act litigation offers a window into a corner of the business world, here grain storage. The court framed the issue this way: “Can a grain elevator company refuse to accept certain corn at its facilities, on the ground that the corn has not received approval from ‘major’ export destinations, and post signs stating this, when the seed producer has received clearances from the United States and several foreign countries, but not from China or the European Union?” The court found no violation of the United States Warehouse Act (USWA), 7 U.S.C. § 241 et seq., or the Lanham Act (and related state law claims).

Syngenta is a major agribusiness company. Bunge operates a number of grain and milling facilities and grain warehouses. Syngenta has developed transgenic corn sold as Agrisure Viptera; the genetic modification is designed to control insects, and also reduces the development of fungus and mycotoxins in stored corn. Viptera corn, indeed, is a federally-registered pesticide licensed under the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA). Based on good experience with growers, “[p]rior to the parties' dispute, Syngenta had projected that Viptera seed sales would exceed twenty percent of the United States corn seed market in future years.”

Then Bunge refused to accept Viptera corn at any of its facilities, on the proffered ground that key countries (China and the EU) had not yet given it regulatory approval. Meanwhile, the USDA and EPA are totally fine with Viptera, as are Canada, Japan, Australia, Brazil, Mexico, New Zealand, the Philippines, Korea, Russia, and Taiwan. Syngenta anticipates Chinese approval by March 2012.

In Spring 2010, when Japanese and Korean approval had yet to materialize, Bunge said that it was unable to accept delivery of Viptera because it hadn’t received those approvals and those are major export destinations. Because all Bunge facilities were “integrated into the export market,” they wouldn’t accept grains or oilseeds containing unapproved products, but the notice said that Bunge would accept Viptera once it was approved in Japan and Korea.

In June, Syngenta got its Japanese approval, whereupon Bunge changed its notice to remove any reference to a specific country (and add another product to the excluded list). Syngenta got Korean approval thereafter, and Bunge changed its posted policy to remove references to Viptera. At that point, Bunge had no policy to reject Viptera until July 2011. After planting time for the 2011-2012 crop year, Bunge again changed its policy.

Bunge wanted China to speed up its approval process, because of concerns about lost sales in the US while grain handlers insisted on awaiting Chinese approval; although China has traditionally been the second largest source of corn in the world (behind the US) and thus not an importer, China suddenly increased corn imports, making it the seventh largest US market for 2009-2010 with a projected rise into the top five for 2011-2012. Bunge had several large contracts to export US corn to China. At the time, Bunge anticipated that commercial Viptera yields in 2011 would be less than half of what Syngenta claimed in this litigation. Bunge decided not to accept Viptera corn in 2011.

Thus, in early July 2011, Bunge posted a new policy on its website and at its facilities rejecting Viptera because it had not received “necessary international approval from major export destinations for the U.S.”

The parties disputed whether China was a “major importer” of US corn. Despite its past history, Bunge had sold millions of dollars of corn to China for late 2011 delivery, and China has a zero tolerance policy pursuant to which it will reject corn deliveries that contain any percentage of corn with unapproved genetic traits. It is relatively common within non-genetically modified corn markets to see a purity level of 98.5 percent; by contrast to China, the EU will accept low levels of unapproved biotech traits.

Syngenta argued that Bunge could reasonably segregate Viptera for non-export uses. But that’s not how Bunge’s facilities are currently set up, and Bunge presented testimony that it would cost $6-8 million per facility to preserve Viptera’s identity, which isn’t commercially reasonable or feasible. Other grain elevators in the same areas may accept Viptera-produced grain or have stated that they will work with farmers so that the warehouses can accept Viptera-produced grain at harvest or direct farmers to facilities that will accept Viptera corn; however, neither Cargill nor ADM will accept Viptera corn at any of their North American wet milling plants until Viptera corn receives regulatory approval from the EU. Unlike Bunge, Cargill operates feed lots and other domestic outlets it can use for such corn.

Syngenta, unsurprisingly, presented evidence of irreparable harm, though it didn’t show any instance in which a farmer was specifically turned away from a Bunge facility for bringing Viptera corn (presumably, most were well-informed enough not to show up). Syngenta argued that “farmers' anger at Syngenta suggests that farmers have been misled into believing that Syngenta did something wrong in marketing Viptera before obtaining all import approvals.” Indeed, Syngenta produced evidence that individual farmers, seed dealers, and local coops have blamed Syngenta for Bunge’s refusal to take Viptera, and one coop canceled an order for $1.5-2 million because of its displeasure over the problem. Syngenta gets between about 5 and 50 calls and about a half dozen e-mails per day from growers that are having difficulty locating outlets for Viptera corn. Some independent seed resellers believe that their own reputations have been injured because of Syngenta. The court had “little doubt” that this was substantial injury that would be difficult to measure in money damages.

Bunge said that this was Syngenta’s fault for putting Viptera on the market before China approved it. Bunge canceled approximately five growers' contracts, because they had grown Viptera corn, and though it has at times assisted farmers with determining where they could deliver Viptera corn, Bunge has no program to do so. Bunge thinks that’s Syngenta’s problem.

The court fond that, before the 2011 planting season, both parties were in a position to recognize that sales to China wouldn’t be possible, but neither made any effort to inform growers of that. Bunge’s contract spoke of rejecting goods “containing transgenic genes/traits that are not approved for sale in Japan, Mexico, The European Union and other U.S. export markets,” and Syngenta’s contract (called a Stewardship Agreement, which is of interest from a patent/bioengineering perspective) stated that “Grower agrees to ... [c]hannel grain produced from Seed to appropriate markets as necessary to prevent movement to markets where the grain has not yet received regulatory approval for import.”

As interesting as this is, does Syngenta have Lanham Act standing? No. Eighth Circuit precedent states that “commercial advertising or promotion” occurs only in statements made by a defendant in commercial competition with the plaintiff. While the parties have customers in common, their relations are at opposite ends of the production process; Syngenta doesn’t compete in grain storage and Bunge doesn’t compete in seed production.

The court went further, though, and held that Syngenta wasn’t likely to succeed because Bunge’s policy wasn’t commercial speech. The Eighth Circuit uses a three-factor test: (i) whether the communication is an advertisement, (ii) whether it refers to a specific product or service, and (iii) whether the speaker has an economic motivation for the speech. Bunge’s policy “relates” to commercial transactions, but doesn’t propose any transaction with Bunge or any rejection of a transaction with Syngenta. It’s a statement that Bunge won’t enter into transactions for Viptera. (Does this mean that refusals to deal are not commercial speech? I think the proper answer is “no,” because it can make sense to ask whether something is commercial speech for purposes of the Lanham Act and the answer might be different for application of the antitrust laws, but the doctrine is, to put it mildly, confused.) Anyway, it’s not enough that Bunge is not a “disinterested, non-commercial party”—there’s still no proposed commercial transaction and thus no likely success on the merits.

There are traditional state-law disparagement claims available against noncompetitors, but Syngenta may not be able to show the necessary level of fault, and the court here didn't give the state-law claims any separate attention.