Vedder Price

Vedder Thinking | Articles Recent Changes in Gray Market Rules

Newsletter/Bulletin

The recent explosion of the international trade of goods over the Internet is undeniable. Trade that was once hindered by customs, distances and language is now greatly facilitated by a "single click" interface. A small "Ma & Pa" store with a website, a PayPal account, a product, a client in a foreign country, and access to a FedEx International account is now engaged in international trade.

New problems are born from this important shift. The first is an increase in the flow of gray market goods sold directly to clients on small scales. Large retailers or wholesalers like Amazon, eBay or Costco struggle with the control of the origin of goods they sell.

Gray market goods are generally defined as the trade of a commodity through distribution channels that, while legal, are unofficial, unauthorized or unintended by the original manufacturer. In the context of an Internet retailer, wholesale prices given to a foreign retailer even with a promise of a minimum sale price can resurface on the Internet at lower sales prices, for example, when promotional codes, or other rebates are provided. A foreign distributor can anonymously open a boutique on Amazon and sell goods in violation of any distributorship agreement. Furthermore, because online shoppers are so price sensitive and tools exist to compare prices of similar items, website purchases are especially easy to divert with a small net rebate.

U.S. Law defines gray market goods, or "parallel imports," as genuine products possessing a brand name protected by a trademark or copyright. They are typically manufactured abroad, and purchased and imported into the U.S. by third parties, thereby bypassing the authorized U.S. distribution channels.

Most goods are protected through the Copyright Act or the Trademark Act. Protection under trademark law includes branding of specific goods (e.g., the Vortex™ wetsuit), the use of house marks (e.g., Tyr® as a producer of wetsuits generally) and/or the use of trade dresses on the product itself or its packaging (e.g., color codes on Tyr’s wetsuits). The Lanham Act establishes that U.S. Customs may prevent the entry of gray market goods as long as certain conditions are met. Section 526 of the Tariff Act prohibits the importation of trademarked goods without the explicit written consent of the owner, but this barrier applies only to goods that are physically and "materially different" from the domestic product likely to cause consumer confusion. If the identical good finds its way back to the United States, retailers cannot use trademark law to bar imports. If the good is "materially different" in any way, imports can be blocked. For example, if Amazon sells in the United States a "materially different" foreign version of a Tyr® wetsuit, an action for trademark infringement is appropriate.

Courts had helped define what constitutes a "material difference." For example, if the goods sent are imported with altered or obliterated serial numbers, imported with non-English language instructions, manuals or labels, the goods are offered at significantly discounted prices without a warranty, or if minor differences in composition or appearances can be found, these imports may be blocked. In the case of the Tyr wetsuits, if the rubber type differs, or if the color coding or sizing differs between countries, trademark law can be used to control imports.

Copyright law can now also be used to control gray market sales. Copyrights in trade goods can be embedded in the good (e.g., the aesthetic design of color stripes printed on a wetsuit), an instruction booklet or even the wording on a package. Under U.S. Law, the importation, without the authority of the owner of the copyright, of a work that has been acquired outside the United States is an infringement of the exclusive right to distribute copies.

Copyright protections differ greatly from trademark protections. The creator of a copyrighted good is entitled to regulate the distribution of that good unless one of the very limited exceptions apply. The first sale doctrine is one of these exceptions. Once a copyright owner consents to the sale of particular copies of his work, he "loses control" over subsequent sales, and may not thereafter exercise the distribution right with respect to that work.

Gray market goods are by definition legally sold to a foreign party and subsequently the scope of consent is exceeded. In Omega S.A. v. Costco Wholesale Corp., the wholesaler Costco legally purchased Omega watches through a New York importer who purchased the watches abroad. Omega took issue with its watches being sold at a large-box wholesaler and argued the first sale doctrine would not apply as these goods were produced abroad and sold to a foreign distributor for sale.

In three precedential cases, the first sale doctrine had been found to apply and the copyright owner was barred from regulated trade of gray market goods once the goods reentered the United States. For example, the doctrine applies when a product is manufactured and sold in the United States, when the good is produced abroad and first sold in the United States, and when the good is manufactured in the United States, sold abroad, and ultimately returned to the United States in a "round" trip.

In Omega, the goods were manufactured abroad, first sold to a foreign distributor and imported into the United States for sale. The distinction is very small, but was sufficient for the courts. These goods were found to not have been "lawfully made under the USA copyright law" and were thus unworthy of protection under the first sale doctrine.

Click below to download the complete newsletter featuring this article.