Gray marketing of imported trademarked goods: tariffs and trademark issues

INTRODUCTION

Sometimes products are diverted from the channels of distribution selected and authorized by the manufacturer and are distributed by unauthorized dealers. Those who oppose diverting goods to unauthorized distributors often refer to this system as the “gray market,” implying that the practice is improper or of only borderline legality.(1) Proponents of diversion, however, maintain there is nothing underhanded or illegal about diversion of goods to unauthorized sellers.(2) Diversions of goods may occur within or across national borders. The volume of gray goods imported into the United States is substantial.(3) Consequently, opponents of gray marketing have launched a political and legal assault against the importation of foreign-produced gray goods.(4) This article reviews a portion of that attack against gray market imports.

The gray market system in trademarked(5) goods consists of genuine trademarked goods produced abroad and diverted to and sold through unauthorized channels of distribution in the United States. These gray market goods are genuine and are stamped with genuine trademarks with the permission of the trademark owners. Hence, gray market goods do not involve an unauthorized trademark that is identical to some genuine trademark.(6) Trading in counterfeit goods is trademark infringement and, if international trafficking is involved, subject to criminal penalties.(7) But importing gray market goods with genuine trademarks is not criminal,(8) and whether it is or should be considered a trademark infringement is a subject of fierce debate.

Several legal theories have been advanced in courts to bar entry of foreign-made gray goods from the United States’ markets. While most of these claims have been rejected by the courts, complainants have had sporadic victories.(9) Most attacks against gray market imports of trademark goods, however, involve claims of violations of the Trademark Act (Lanham Act) of 1946(10) or the Tariff Act of 1930.(11)

This article discusses the impact of the litigation against gray market imports on the development of U.S. tariff and U.S. trademark law. It begins with a discussion of the types and causes of both domestic and international gray markets. It also reviews the historical background of U.S. laws and policies dealing with both domestic and imported gray market goods. Then a review of recent litigation involving Customs Service regulations under the Tariff Act dealing with imported gray goods is presented. Letigation of trademark issues under the Lanham Act in cases involving imports of gray goods is also reviewed. Finally, the article concludes: (1) that a coherent policy for dealing with gray market imports cannot be developed through litigation, (2) that legislation is needed to forestall the potential judicial expansion of trademark law into an import ban on gray goods, and (3) that legislation requiring labels on imported gray goods is needed to protect consumers.

Gray Marketing: Domestic and International

Unless some attributes of the international movement of gray goods suggest otherwise, one would expect U.S. policy in treatment of gray imports to mirror domestic policy for domestic gray goods. The debates concerning domestic gray marketing have centered largely around antitrust considerations. Antitrust questions in gray market situations usually ask whether a manufacturer can contractually restrict its buyers from dealing with gray marketers. Antitrust law permits some contractual restrictions, but their private enforcement often has been unsuccessful. In contrast, U.S. trademark law has not been a legal means for trademark owners to ban intrastate or interstate movement of gray goods to gray dealers.

Domestic Gray Marketing

One type of domestic gray market arises when some retailers offer unauthorized sales to other retailers. The diverting retailers purchase in large quantities in order to take advantage of volume discount programs offered by manufacturers.(12) The large volume dealers then resell the manufacturer’s goods to small retailers at lower prices than would be available on direct order from the manufacturer. Such retailers are diverting the goods from the authorized channel. Since the manufacturer loses a percentage of the profit margin on the units sold from the diverting retailers, manufacturers often attempt to eliminate “flawed” discount schedules or enter into enforceable contractual arrangements with retailers in an attempt to ban diversions.(13)

A second type of domestic gray market involves wholesale-distributor diversions that occur when sales are made to unauthorized distributors or retailers. The diverting distributors increase their sales volume as well as increase the manufacturer’s sales volume with no loss of the manufacturer’s profit margin. Therefore, manufacturers have little incentive to eliminate these gray channels of distribution unless they are pressured to do so by authorized channel members.(14) However, since authorized retailers lose consumer sales to gray market retailers and authorized wholesale-distributors may suffer a loss of sales volume to the diverting wholesale-distributor, manufacturers are often pressured by these authorized channel members to stop the diversion.

In addition to the “flawed” volume discount schedules phenomenon, domestic gray markets often arise when an organized distribution channel performs extensive marketing functions.(15) Marketers may need to invest money in carrying a full line of models for display, employing and instructing sales personnel about the product’s features, or advertising the product to potential customers. The dealers may also provide warranty and repair services. The dealer, of course, will engage in these functions only if the costs can be recaptured in the price of the sold product. If the conventional channels of distribution maintain high gross profit margins to pay these marketing costs, there is an opportunity for gray marketers to obtain diverted goods and prosper on lower margins by not performing as many marketing activities or performing the marketing tasks at lower costs.

Authorized distributors often complain to manufacturers about the low prices of stores selling gray (diverted) goods.(16) Consequently, manufacturers have used many techniques either to stop diversions of their products from the authorized distribution channels or to stop price discounting of their products by gray retailers.

One method to avoid price-cutting is to require dealer maintenance of the manufacturer’s mandated resale price.(17) Since 1911, however, the Supreme Court has held contractual agreements designed to maintain retail prices after the manufacturer had parted with title to the goods to be illegal under the antitrust laws.(18) To circumvent the Court’s ban on vertical price-fixing, proponents of the practice of resale price maintenance were able to persuade Congress to exempt resale price maintenance agreements from antitrust laws if the state legislatures enacted provisions authorizing these agreements.(19) Nearly all states enacted so-called “fair trade” laws that permitted the manufacturer to set the retail price on its trademarked good and to require all dealers in the state to sell only at that price.(20) The fair trade (resale price fixing) movement peaked in the 1950s with over 1600 manufacturers enforcing fair trade agreements.(21)

Legal setbacks and the growing pressures of competition slowly eroded the successes of the fair trade movement. State and federal courts ruled that fair trade statutes were legally unenforceable in various respects.(22) Consequently, retailers in many states in which fair trade statutes were not completely enforceable were able to ignore the manufacturer’s (trademark owner’s) prescribed minimum prices. Moreover, mail order houses in nonfair trade states shipped merchandise at reduced prices to customers in fair trade states. Federal courts ruled that fair trade states could not enjoin the shipment of interstate merchandise into their area.(23) Without bans on interstate sales of fair trade items, the forces of interstate competition eroded the effects of the fair trade laws. Thus, Congress repealed the “fair trade” exemption from antitrust laws in 1975.(24) Without any “fair trade” exemption, courts interpreting the antitrust laws have condemned all vertical price fixing.(25) Therefore, resale price maintenance is not currently available to manufacturers (trademark owners) as a technique to eliminate the price-discounting of either authorized or unauthorized (gray) dealers of trademarked goods.

Furthermore, the Supreme Court has held that the existence of a trademark on a product does not justify a seller’s control over resale prices charged by distributors down the chain of distribution.(26) In a leading case, the Court wrote:

Soft-Life is the distributor of an unpatented article. It sells to its

wholesalers at prices satisfactory to itself. Beyond that point it may

not project its power over the prices of its wholesale customers by

agreement. A distributor of a trademarked article may not lawfully

limit by agreement, expressed or implied, the price at which or the

persons to whom its purchaser may resell….(27) Moreover, a manufacturer and owner of a trademark cannot bring a trademark infringement action against someone who buys an item in a low price area of the United States and sells it in a high price area.(28)

As an alternative to vertical price-fixing, manufacturers often impose contractual nonprice restraints on distributors in an effort to prohibit diversions of goods and to encourage higher resale prices by authorized distributors. For example, the manufacturer might require the authorized retailer not to resell (divert) the merchandise to other merchants that discount prices. Alternatively, the manufacturer could require the authorized distributor not to sell in another dealer’s territory. A less restrictive version of a territorial restraint could include delivery of the items to a designated location and a prohibition against the dealer setting up branch sales outlets. If successful, these nonprice restraints eliminate diversions and price-discounting. They provide additional profit margins for the authorized distributors to recapture their marketing costs for their expanded sales efforts. The manufacturer anticipates that the expanded volume of units sold through the distributors’ increased promotional efforts may reduce unit production costs for the manufacturer. The consumer may ultimately share in these lower production costs through long-term price reductions. The consumer may also obtain more services provided by the retail outlets.

Many economists argue that vertical nonprice restraints are pro-competitive.(29) Since contractual resale restrictions only eliminate competition between the dealers who sell the manufacturer’s brand, brands of other manufacturers continue to compete in the market for the consumers’ dollars. Hence, the nonprice restraints on dealers only eliminate intrabrand competition but may improve the manufacturer’s sales efforts in interbrand competition with other manufacturers’ brands. Therefore, these economists argue that private contractual restraints cause only insubstantial harm to the overall level of competition. Conceding that intrabrand competition is reduced, they argue that interbrand competition is improved more. The improved marketing efforts of the distributors enhance the manufacturer’s and distributor’s competition against the brands of other manufacturers. Furthermore, they characterize the retailers who price discount as “free riders.” They are said to take a “free ride”(30) on the authorized dealers’ marketing investments by, for example, obtaining sales from advertising paid for by the authorized dealer.

On the other hand, opponents of vertical arrangements have argued that in some industries the intrabrand competition eliminated by vertical restraints is significant competition that should not be lost.(31) They point out that the elimination of any intrabrand competition in industries in which only a few brands exist could enhance possibilities of manufacturer collusion and could have adverse effects on consumer welfare. Even if brands proliferate, opponents assert that competition between dealerships selling the same brand is too significant to a competitive system to permit its elimination.

The opponents of restraints on intrabrand competition also have argued that the free rider model is incorrect in equating authorized distributors with discounters except for marketing services.(32) Instead, they contend that discounters should be viewed as providing new and different services that permit lower prices. For example, discounters may offer mail order services, pay lower commissions to salespersons, use “zero” inventory techniques, provide minimal interior decorating, or advertise less. These savings permit lower pricing. Opponents of intrabrand restraints argue that it is more economically efficient to let the consumers decide what marketing services they want by choosing which dealers to patronize than it is to permit contractual agreements that eliminate marketing variations like those provided by price discounting stores.

Lawmakers have vacillated in developing public policies concerning intrabrand competition. Initially, the Supreme Court rejected the approach of per se illegality in regard to vertical nonprice restraints.(33) But in the late sixties, the Court determined that such restraints were indeed per se illegal.(34) This strict approach was short-lived, however. In the late seventies, the Supreme Court ruled that nonprice vertical restrictions on distributors were to be tested under the antitrust “rule of reason.”(35) The Court specifically stated that interbrand competition, not intrabrand competition, was the “primary concern of antitrust law.”(36) Hence, most litigated cases in the eighties found justifications for nonprice vertical restraints on the basis that the restraint was reasonably necessary to combat free riding or to promote competition among brands.(37)

While these contractual nonprice restraints may be permitted today, manufacturers still have the burden of “policing” or identifying those distributors engaged in diversion of goods to gray marketers. Policing these contracts, however, can be so difficult that the elimination of diversion of goods may be impractical, if not impossible, for many manufacturers.(38)

Those merchants diverting goods to gray marketers do not violate the law. The firm selling to diverters may be in breach of the manufacturer’s contract containing the restriction not to sell to price discounters. Termination of such dealers may be legally permissible, but because of the possibly significant sales volume of the dealer, termination may not be practical. Moreover, the manufacturer has no legal remedies against the gray market buyers who purchase from the diverting sellers. The buying and reselling of diverted trademarked goods is not a trademark infringement or other illegal act.

Hence, policy concerning domestic gray marketing is generally one of governmental neutrality. The government has not outlawed diversion of goods to unauthorized dealers. Trademark law provides trademark owners with no protection against subsequent sales of the trademarked goods. Nor has the government, through trademark law or otherwise, permitted a ban on interstate shipments of diverted goods. Instead, the Supreme Court has insisted that trade between the states not be restricted by state fair trade laws. Free trade among the states includes the right to ship gray goods across state lines. While the courts will permit contractual arrangements in which manufacturers attempt to eliminate diversions to gray marketers, policing these contracts by the manufacturers proves too difficult.

International Gray Marketing

It is reasonable to expect that governmental policy in relation to domestic gray markets would carry over to the formulation of policy for gray imports. However, “midnight” legislation(39) to protect American firms from congressionally perceived unfair competition from abroad and litigation over the expansion of trademark rights has frustrated the development of a policy for gray imports that is consistent with the policy for domestic gray markets. To grasp the development of that inconsistency, it is necessary to understand the international gray marketing systems and of the history of legislation and cases concerning gray imports.

International gray marketing may occur in a variety of situations, but most efforts fall into two basic patterns–either a parallel import system (gray importer competing with an authorized importer) or imported goods of foreign affiliates of U.S. producers (a gray importer competing with a domestic producer).

A parallel import system may be created by gray marketers. A foreign manufacturer may establish an authorized importer to sell its goods to U.S. retailers. Outside the authorized chain of distribution, gray market importers create a parallel distribution system when they purchase the goods abroad and import the goods for resale to gray market retailers in the United States.

Parallel importation (a second importer) may occur in two basic organizational variations. In the first, a French manufacturer might sell its trademark rights to a U.S. firm which then registers and uses the former’s trademark as a U.S. trademark. The U.S. firm then imports and sells the products of the French firm in the United States. If the French manufacturer directly exports its goods to the United States or if a third party purchases them abroad and imports them, this second (parallel) importation could jeopardize the U.S. trademark owner’s investment in the trademark. In this instance, the parallel importation threatens the American firm’s business.(40) In the other variation, a Japanese company might incorporate a U.S. subsidiary to import and sell its goods to authorized U.S. retailers. Gray marketers then might purchase the Japanese firm’s products abroad and import them to the U.S. in competition with the authorized distribution network of the Japanese firm. In this case, the economic injury resulting from the unauthorized importers falls upon the Japanese-owned manufacturer and its distribution network.(41) Legislators or judges reviewing these factual patterns may perceive a U.S. interest in the first instance in need of protection, but a foreign firm’s interest in the second instance that does not need protection. Hence, these organizational variations may bring out American protectionist bias when preparing legislation or deciding cases.

A second international gray market system arises when goods produced abroad by manufacturing affiliates of U.S. firms are imported. Such goods are produced abroad for sale abroad. Whether these overseas manufacturing operations are organizational divisions, subsidiary corporations, or authorized licensees of the U.S. trademark owner, these affiliated foreign manufacturers imprint trademarks identical to U.S. trademarks on foreign-produced goods.(42) Diversions then arise when a foreign distributor sells to gray market importers. The importers bring the goods to the U.S. and sell them to gray market retailers in competition with the authorized U.S. dealers of the American producer. In these instances, unauthorized imports compete with domestically produced goods

Whether the gray market goods are produced by a non-U.S. affiliated foreign producer (parallel importation) or by a foreign producer affiliated with a U.S. firm, an international gray marketing opportunity arises when the foreign manufacturer’s prices to distributors vary in different countries.(44) If the price to foreign distributors is less than the price to U.S. distributors and if the price difference exceeds shipping costs to the United States, then foreign distributors can profit from selling directly to U.S. gray marketers or to importer-distributors for resale to retail gray marketers.

However, even if U.S. manufacturing prices are the same as prices in other countries, gray market imports may still occur.(45) If the marketing value added to products by U.S. distributors results in a U.S. price exceeding the foreign price plus shipping cost of diverted foreign products, gray market imports to the U.S. will still occur. If the U.S. marketing costs exceed the shipping costs, the gray marketer has an opportunity to profit by selling the import product without incurring all the marketing costs.

The growth of gray market imports to U.S. markets in the last decade has been further fueled by the high value of the dollar.(46) An increase in the value of the dollar relative to currencies of other nations increases the relative value of investments made in the United States, such as the value of U.S. distributors’ investments in marketing. These high marketing investments increase profit opportunities for others who import gray market goods. Any exchange rate changes that strengthen the dollar will lower the prices of foreign-made goods and require an adjustment in the prices of U.S. goods. However, U.S. firms may not be able or willing to make price adjustments in U.S. markets in response to the exchange rate fluctuations. Professional arbitragers have emerged to monitor exchange rate changes and to maintain sufficient capital and contacts with gray retailers to take advantage of adjustment delays. Thus, the failure of established U.S. marketing channels to respond quickly to currency fluctuations has been a major cause of the emergence of international gray markets.

The Tariff Act Restrictions and Early Developments

Like domestic policy on gray marketing, U.S. policy on international gray marketing also has vacillated. Until 1922, the U.S. government did not prohibit the importation of trademarked goods by gray marketers.(47) That year, Congress passed the Genuine Goods Exclusion Act that was subsequently inserted as section 526 of the Tariff Act of 1930.(48) The next year, the United States Supreme Court issued a decision that found certain types of gray imports to be in violation of trademark law.(49) The 1922 Act of Congress and the 1923 Supreme Court opinion have a common origin, the United States Court of Appeals for the Second Circuit’s decision in Bourjois & Co. v. Katzel(50) in 1921.

In Katzel, a French manufacturer of “Java” face powder sold its entire U.S. operation and U.S. trademark rights to Bourjois. Bourjois imported and repackaged the face powder under the “Java” trademark. However, Katzel bought the powder from European distributors of the French manufacturer and imported it for sale in the original French packaging. Bourjois brought suit against Katzel, claiming the sale of the “Java” imports violated Bourjois’ U.S. trademark rights. The Trademark Act of 1905 prohibited the importation of goods bearing trademarks that “copy or simulate” U.S. trade-marks.(51) The United States Court of Appeals for the Second Circuit held that the genuine trademark on the challenged imports did not copy or simulate” the plaintiff’s mark in violation of the Trademark Act.(52) The law was not intended, the court said, to bar trademarked imports if the mark accurately described the manufacturing source for the goods.

In an effort to reverse the Second Circuit decision, Congress added section 526 as a floor amendment to the Tariff Act of 1922.(53) Section 526 permits the owner of a registered U.S. trademark to record the trademark with the Customs Service and thereby exclude importation of goods produced abroad that bear an identical trademark.(54) It prohibits entry unless written consent of the owner of the trademark is produced at the time of entry. Section 526 is not a trademark statute. No finding of trademark infringement is necessary. Only ownership of a U.S. trademark is required.

Shortly after section 526 was enacted, the United States Supreme Court reversed the Second Circuit’s ruling.(55) It held that the Trademark Act of 1905 outlawed importation of trademarked goods from a foreign manufacturer when the foreign manufacturer had sold the U.S. trademark to the U.S. owner. Despite the Supreme Court’s reversal in Katzel, section 526 remained.

Section 526 was passed with only a few minutes of debate and without legislative hearings or reports.(56) Hence its limited legislative history reveals a hastily drawn and enacted legislative provision. Some interpreters discern a legislative intent to prevent the perceived inequity allowed by the Second Circuit.(57) These commentators argue that section 526 should not be given range far afield from the precise context of Katzel. Others, however, discount the significance of the floor debate and argue section 526 is not limited by the Katzel context.(58)

The Customs Service, which is responsible for enforcing section 526, adopted the view that Katzel involved a limited factual situation that should narrow the import ban provided by the section.(59) The Service has pointed out that the Court in Katzel was faced with the rights of an independent domestic trademark owner that had invested substantial dollars in purchasing a trademark from a foreign manufacturer and in developing a domestic trademark identity distinct from that of the foreign trademark owner. It has contended that the focus of the Supreme Court in Katzel was on the prevention of fraud against domestic companies that had purchased a trademark from foreign firms. The Customs Service has further contended that parallel importation was deemed inequitable by the Court when an independent U.S. firm had purchased the trademark for U.S. distribution purposes. Thus, the Customs Service has developed regulations that limit the import ban of section 526 to Katzel situations,(60) denying the import ban to firms trying to stop the importation of goods produced by their foreign affiliates.(61)

A second case also has fueled the controversy concerning the Customs Service’s interpretation of section 526 and has introduced a possible conflict with antitrust law. The initial Customs Service regulations pursuant to section 526 provided for the exclusion of all foreign goods bearing registered U.S. trademarks without the U.S. trademark owner’s written consent.(62) However, in 1936 the Customs Service created an exception to the ban on importation when the foreign and domestic mark owners were “related parties.”(63) In 1953, the Customs Service expanded the regulations to a “related companies” exception.(64) This exception allowed imports without permission from the trademark holder when the owner of the U.S. trademark was “related” to the owner of the foreign trademark. In effect, the Service ruled that the relatedness of the parties precluded any finding of independence of the U.S. trademark owner as required by Katzel. However, in the early fifties the Customs Service’s enforcement practices were often inconsistent with its “related companies” exception.(65) In practice, it sometimes excluded genuine goods regardless of whether the U.S. trademark owner was related to the foreign manufacturer. The permissiveness of the Customs Service’s ban on imports of genuine goods, despite its regulations that denied the import ban to “related” companies, led the Justice Department, apparently without consulting the Customs Service, to file charges against certain defendants who were using the import ban to allegedly monopolize the U.S. market for such trademarked good.(66)

In United States v. Guerlain,(67) the Department of Justice charged three defendants — Guerlain, Parfums Corday, and Lanvin Parfums — with attempting to monopolize and monopolizing the importation and sale within the United States of certain trademark perfumes in violation of the Sherman Act. The Justice Department’s theory was that an American owner of the trademark could not properly invoke section 526 to block gray market imports and thereby monopolize that trademark brand’s market in the United States. Furthermore, the government contended that the American owners of the trademark rights of the French perfume were not entitled to invoke section 526 to prohibit gray market imports because the American holder of the trademark and the foreign manufacturer of the perfume were so affiliated as to “constitute a single international enterprise.”(68)

The district court accepted the Government’s — contentions that defendants had engaged in an antitrust violation and that section 526 could not be utilized by American companies that were affiliated with the foreign manufacturer so as to constitute “a single international enterprise.” Guerlain was appealed and, while pending, the Solicitor General filed a motion with the Supreme Court to vacate the judgment and remand the case to the district court so that the Government could move to dismiss its own case.(69) The Solicitor General reported that the Antitrust Division and the Customs Service did not agree on the interpretation of section 526. He further reported to the Court that, unlike the Antitrust Division and its theory in Guerlain, the Customs Service judged itself “legally constrained” to ban genuine goods even if the U.S. trademark holder was affiliated with the foreign trademark owner.(70) Hence, the Solicitor General conceded that the district court’s interpretation that Section 526 was not properly available to related companies was “permissible” but “not supported by the literal terms of the statute.”(71) Therefore, the Government sought to vacate the judgment in order to introduce legislation to narrow the language of section 526.

Subsequently, the Eisenhower Administration prepared legislation to amend section 526 so that it did not provide an import ban to the American part of a single international enterprise.(72) The proposal was never enacted. Thereafter, the Customs Service deleted the “related company” restriction from its regulations.(73) However, in 1972, the Customs Service adopted new regulations spelling out restrictions based on the relationship of foreign and U.S. companies.(74) These revised regulations denied U.S. trademark owners the right to compel the Customs Service to exclude genuine trademark goods produced abroad when the owner of the foreign trademark was affiliated (a division or subsidiary) with the U.S. trademark owner or had applied the trademark with the authorization (license) of the U.S. trademark owner.

The Customs Service has argued that it is a different situation, unlike a Katzel situation, when the owners of the U.S. and foreign trademarks are corporate affiliates or essentially the same corporate being. In these situations, the Customs Service regulations permit “genuine goods” importation. To ban imports in these circumstances, the Customs Service has argued, would permit the domestic and foreign trademark owners to gain governmental protection against price competition from their own merchandise. Rather than protecting truly independent U.S. firms that had purchased foreign trademarks, section 526, according to the Customs Service, would provide a means for multinational firms to price discriminate among nations. Hence, the Customs Service maintains that section 526 protects independent U.S. firms only in Katzel-type situations.”(75)

RECENT LITIGATION OF TARIFF ACT SECTION 526

Asserting that the common-control and authorized-use exceptions in the Customs Service regulations of 1972 were inconsistent with Section 526 of the 1930 Tariff Act, U.S. trademark owners have sought a declaration that the Customs Service regulations were invalid and unenforceable. In Vivitar Corp. v. United States,(76) Vivitar Corporation filed suit in the United States Court of International Trade to have the Customs Service regulations declared ultra vires. In COPIAT v. United States(77) and in Olympus Corp. v. United States,(78) COPIAT and Olympus filed similar actions in the district courts.

The petitioners in these actions against the Customs Service presented the same basic arguments to invalidate the Customs Service regulations.(79) First, they argued that the regulations were contrary to the unambiguous language contained in section 526 and that its legislative history did not reveal a congressional intent contrary to the “plain” statutory language. Second, they argued that the Customs regulations had not been longstanding or consistent and, therefore, were not entitled to deference by the courts. Finally, they asserted that the regulations were not ratified or approved by Congress when it had considered amendments to section 526. In opposition, the Customs Service argued that its regulations were reasonable interpretations, consistent with the legislative history and the Katzel decision.(80) Furthermore, it argued its long-standing regulations were entitled to deference by the courts and had been approved by recent legislative activities.(81)

Although the Court of International Trade and district courts rejected the plaintiffs’ arguments, the appellate decisions were not consistent. The Second Circuit in Olympus(82) affirmed all three justifications offered by the Custom Service while the United States Court of Appeals for the District of Columbia and the United States Court of Appeals for the Federal Circuit in COPIAT(83) and Vivitar(84) agreed that such justifications were insufficient to support the Customs Service regulations in light of the statutory language. However, the Federal Circuit court in Vivitar did provide its own justification for the Customs regulations, arguing that they represented “a reasonable exercise of administratively initiated enforcement.”(85) The D.C. Circuit court in COPIAT refused to take this extra step because it concluded that the Customs Service regulations could not be upheld except on grounds put forth by the agency itself.(86) Thus, the D.C. Circuit court struck down the regulations.

The K mart Decision

The D.C. Circuit Court decision in COPIAT was appealed and consolidated with other cases. In 1988, the U.S. Supreme Court decided K mart v. Cartier,(87) involving the section 526 controversy. Initially, the Court set out the analytic approach(88) for reviewing the validity of challenged administrative regulations. It stated that the court must first ascertain the plain meaning of the statute by looking at the particular statutory language at issue as well as the language and design of the statute as a whole. If the statutory language is determined to be clear and unambiguous, the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. Agency regulations must not alter the clearly expressed intent of Congress. On the other hand, if the court determines the statute is silent or ambiguous with respect to the specific issue, the court must determine whether the agency regulation is a permissible interpretation of the statute. If the agency regulation is not in conflict with the plain language of the statute, the court must give deference to the agency’s interpretation of the statute. Following this analysis, the Supreme Court concluded that section 526 requires consent of the trademark owner to import a U.S. trademarked product if (1) the product is “of foreign manufacture” and (2) the trademark it bears is “owned by” either a U.S. citizen or U.S. corporation.(89)

According to the Court, gray market goods arise in one of “three general contexts.”(90) The first context, Case 1, is referred to as a” prototypical gray market” case. Case 1 is based on the facts of Katzel. There was no dispute among the Justices that the Customs Service regulations were valid insofar as they barred importation of gray goods in Case 1 situations because unambiguously the trademarked product was “of foreign manufacture” and the trademark was “owned by” a U.S. company.(91)

A second gray market case, Case 2, involves the “related companies” situation. The Court discussed three factual variations of Case 2.(92) The Court labeled Case 2a as a foreign firm incorporating a U.S. subsidiary to distribute its goods in the United States. The subsidiary holds the registration on a U.S. trademark identical to the foreign trademark of the parent company. All nine Justices — albeit in three separate opinions — agreed that the Customs Service regulations were lawful in permitting importation of gray goods in the Case 2a situation.(93) All three opinions agreed that the statutory phrase “owned by” was ambiguous in situations involving a foreign parent. The Court thought that “owned by” was ambiguous enough that they were unable to determine which of the two entities involved in a foreign parent/U.S. subsidiary situation can be said to “own” the U.S. trademark if the domestic subsidiary is wholly owned by its foreign parent. Hence, section 526 does not unambiguously cover the situation in which a domestic subsidiary of a foreign manufacturer registers its parent’s trademark in the United States because the trademark is not clearly “owned by” a domestic firm. Given this ambiguity, the Customs Service interpretation excluding such subsidiaries of foreign parents from section 526 protection was held to be reasonable.

The Court also identified the situation when an American firm creates overseas a foreign subsidiary, Case 2b, or an unincorporated

division, Case 2c, to manufacture its U.S. trademarked goods for sale abroad or for importation into the United States for distribution. A majority(94) concluded that the Customs Service could reasonably interpret section 526 as not including any goods diverted from these subsidiaries or divisions for import into the United States. The phrase “merchandise of foreign manufacture” was ambiguous in these situations. That phrase could readily be interpreted to mean either “merchandise manufactured in a foreign country” or “merchandise manufactured by a foreigner.”(95) Given the imprecision of the statute, the agency was entitled to choose any reasonable definition. The interpretation that goods manufactured by a “foreign subsidiary or division” of a domestic company are not goods “of foreign manufacture” was viewed as a reasonable interpretation.

The Court also identified a third gray market situation. Case 3 involves a domestic holder of a U.S. trademark that authorizes an independent foreign manufacturer, by license or assignment, to use the mark on goods manufactured overseas. The Customs Service regulation permitted importation of such goods by gray marketers. However, another majority of the Court(96) thought that the Customs Service “authorized use” exception to the import ban of section 526 could not be upheld. The statutory phrases “owned by” and “merchandise of foreign manufacture” were not ambiguous in relation to the foreign licensing situation because, despite the grant of a license, the U.S. firm still owns the U.S. trademark and the goods are clearly manufactured by an independent foreign firm. Yet, the Customs Service regulation denied the domestic trademark owner the power to prohibit the importation of goods made by an independent foreign manufacturer merely because the domestic trademark owner had authorized the foreign manufacturer to use the trademark. The Court concluded that the Customs Service’s “authorized-use” exception to the import ban was not a reasonable interpretation of the statutory language because the goods were “merchandise of foreign manufacture” and the trademark was “owned by” a U.S. firm. Therefore, the Customs Service’s “authorized-use” exception to the import ban was declared invalid.

Thus, U.S. policy concerning gray market imports was changed slightly with the K mart decision. Trademarked goods produced abroad under a license from a U.S. trademark owner can now be banned from importation. This, of course, is true only if the U.S. and foreign trademarks are separately owned and controlled. Though goods implicated in this Case 3 situation (licensing) account for only about ten percent of the dollar volume of yearly gray market imports,(97) K mart decision creates an opportunity for corporate restructuring to obtain the benefits of section 526’s ban on imports.(98) Elimination of corporate entanglements and control is a prerequisite for the establishment of a mere licensing situation. For some companies, the restructuring may be feasible.

Section 526 Private Actions

Section 526(c) of the Tariff Act provides a private right of action.(99) Prior to the K mart decision, some lower courts held that, despite the Customs Service regulations permitting some imports, private actions to bar such imports were possible. Both the Federal Circuit in Vivitar(100) and the Second Circuit in Olympus(101) ruled that the Customs Service’s interpretation of section 526 only limits the Customs Service’s obligations to enforce the section by excluding goods. Irrespective of the Customs Service’s interpretation, the mark owner still has the right to “pursue private remedies against the importer under section 526(c), notwithstanding Customs’ failure to exclude the goods.”(102)

After the K mart decision in 1988, lower courts have continued to permit private actions under section 526(c).(103) However, some courts have begun to impose the “common control” exception in private actions as well. In Yamaha Corp. of America v. ABC International Traders Corp.,(104) a California district court followed K mart. Since the Customs Service’s regulations were upheld as reasonable in K mart, the court interpreted section 526 to have the same scope: if there is a parent-subsidiary relationship between the foreign manufacturer and the U.S. distributor, the Tariff Act cannot be used by private litigants to bar imports of gray goods.

The Third Circuit also overturned a pre-K mart district court decision that held the Customs Service regulations inapplicable to private actions. In Weil Ceramics and Glass, Inc. v. Dash(105), the court found that K mart created an absolute exception to section 526’s ban when “common control” was present. Thus, the court concluded that when the U.S. importer is a wholly owned subsidiary or division of a foreign manufacturer, section 526(c) should be interpreted consistently with the Supreme Court’s K mart decision. However, the Third Circuit was careful to point out that its decision in Weil did not disturb its former decision that separate entities without any “common control” may utilize section 526(c) to ban imports of genuine goods.(106)

Thus, the lower courts appear to be in agreement that private actions under section 526(c) may result in court orders to ban imports when no “common control” exists. However, if courts in future litigation follow the Third Circuit’s Weil decision, the “common control” exception to the ban will be applied in private actions, just as the exception was upheld in K mart. Then, private actions by U.S. trademark owners who are affiliated with the foreign producer of the genuine goods may not obtain a court order against the importer and thereby ban the goods. In effect, the Customs Services’ regulations, as upheld in K mart, will not only be valid operational policy for the Customs Service but also will be controlling interpretation in private actions as well.

LITIGATION OF TRADEMARK ISSUES

Though K mart prevents affiliated companies from invoking the import ban of section 526, it does not appear to preclude companies from invoking the trademark laws(107) against the importation or subsequent sale of imports. The decision did not refer to either the Lanham (Trademark) Act(108) or to the Court’s prior decision in Katzel. As a result, the questions of whether trademark laws can be used either to ban imports or to seek damages from gray importers for trademark infringement are still being litigated.

Trademark Functions

The original function of a trademark was merely to indicate the source or origin of goods by identifying the producer.(109) The purpose of the trademark was to prevent “palming off,” that is, passing off goods of one producer as those of another. Protection of the public was the primary goal of common law trademark. Some of today’s courts continue to view protection of the public as the primary rationale for trademark law.(110)

Producers who used trademarks to protect the public found that the trademark was also a means of gaining an edge over competitors.(111) Besides merely using trademarks to prevent competitors from “palming off” on the trademark, sellers used the trademark symbol in promotional activities and the creation of consumer loyalty to the mark. Consumer loyalty to the trademark symbol becomes part of the business’s goodwill.

Over time, this dual function of trademarks has become more explicit in court decisions(112) and in legislative enactments. In 1946 Congress recognized the two-fold purpose of trademark law in the Senate Report on the Lanham Act:

One [purpose of the trademark law] is to protect the public so it
may be confident that in purchasing a product bearing a particular
trademark which it favorably knows, it will get the product which
it asks for and wants to get. Secondly, where the owner of a
trademark has spent energy, time, and money in presenting to the
public the product, he is protected in his investment from its
misappropriation by pirates and cheats. This is a well established
rule of law protecting both the public and the trade-mark owner.(113)

With the expansion of advertising in this century, producers shifted the emphasis of their messages from identifying the producer of the product to asserting the product and the trademark itself had attributes that consumers preferred. If the trademark is sufficiently advertised as representing quality goods, it comes to function as a tool for consumers to identify and to attribute to products those qualities of consumer preference that previous advertising and consumer use of the product have established. Hence, the trademark itself becomes valuable. It comes to symbolize a reputation that can be relied upon by consumers even though consumers may not know or care who the producer is.(114)

As the function of a trademark changed to include an embodiment of the owner’s reputation and goodwill, the standard for trademark infringement has also changed.(115) Trademark protection has been extended by some courts to a prohibition against any confusingly similar trademarks.(116) This protection of trademark goodwill may involve the protection of the trademark owner’s investment in the mark, rather than protection of the public from confusion as to product source. Hence, to some courts the trademark owner has the right to protect its reputation from any association with goods of another.

The evolution of the goodwill theory for trademarks has created considerable difficulties for legislators and courts, both of which have often disagreed about how far to extend the protection of trademark owners. Despite legislative changes, many courts still seem to consider protection of the public, rather than trademark investments, to be the primary purpose of trademark law.(117)

Statutory Provisions

There are two sections of the Trademark (Lanham) Act utilized by trademark owners to challenge the importation and sale of gray goods. Section 42 of the Lanham Act allows a trademark owner to record its registered mark with the Customs Office to prevent the importation of goods bearing a copy or simulation of the registered mark.(118) Obviously, this statute is similar to section 526 of the Tariff Act. Indeed, the Customs Service regulations for an import ban were created to enforce both section 526 (Tariff Act) and section 42 (Lanham Act).(119) Hence, a plaintiff seeking to bar entry of gray goods will normally seek relief under both section 42 of the Lanham Act and section 526 of the Tariff Act. However, courts have not developed a universally accepted definition of a copy or simulation of a mark.

The second section of the Lanham Act involved in gray market litigation is section 32 which protects against the use of a “reproduction, counterfeit, copy or colorable imitation” of a registered trademark that is likely to cause confusion, mistake or deception of the purchasers.(120) Cases involving gray market goods have not developed clear standards to determine when a “likelihood of confusion” exists. Courts find it necessary to review situations on a case by case basis.

Exhaustion and Universality Doctrines

There are two other trademark doctrines that, if recognized by the courts, preclude any discussion of trademark infringement. The exhaustion doctrine holds that once trademarked goods have been released (sold) in the stream of commerce, the trademark owner may not prohibit the resale through use of any trademark action.(121) It is not a trademark infringement to resell trademarked goods.

Connected to the exhaustion doctrine is the universality principle that declares that trademarks run with the goods even across national borders.(122) Hence, the exhaustion doctrine applies to international sales. The sale of trademark goods anywhere in the world exhausts the mark owner’s rights in all countries.

The seminal gray marketing importation case announcing the universality principle in the United States was Apollinaris Co. v. Scherer(123) in 1886. The plaintiff held the contractual rights to be the exclusive distributor in the United States of mineral water bottled in Hungary under the Hungarian trademark “Hunyadi Janos.” Because the defendant was unable to buy from the Hungarian firm, it purchased the water from diverters in Germany for importation to the United States. The court recognized that the plaintiff’s business was harmed by the importation in that the value of the exclusive distributorship agreement was being eroded, but the court ruled that there was no trademark infringement:

The defendant is selling the genuine water…. There is no exclusive
right to the use of a name or symbol… except to denote the
authenticity of the article with which it has become identified by
association. The name has no office except to vouch for the genuineness
of the thing which it distinguishes from all counterfeits ….(124) Since the defendant was not a party to the exclusive distribution agreement and had acquired a valid ownership to the water, it could “treat it as [its] own property.”(125) Trademark law provided no legal redress against the defendant as a reseller of genuine trademarked goods.

In 1916, the Second Circuit followed Apollinaris in the Fred Gretsch Manufacturing Co. v. Schoening case.(126) The court permitted importation of “Eternelle” violin strings that the defendant had purchased from European distributors of the German manufacturer. The authorized U.S. distributor had registered the trademark of the foreign manufacturer. Section 27 of the Trademark Act of 1905 prohibited entry of goods if they bore a trademark that copied or simulated a registered trademark, but the court held the imported trademark goods did not “copy or simulate” because they bore a trademark that correctly identified them.

Thus, through the first two decades of the twentieth century, internationally diverted trademarked goods were held to be importable into the United States. The exhaustion and universality doctrines permitted free importation of genuine trademarked goods that were judged not to “copy or simulate” in violation of U.S. trademark law.

Katzel and Aldridge — Trademark Issues

In 1921 the issue of gray market importing again reached the Second Circuit. The Katzel case,(127) as previously discussed,(128) involved a French cosmetics manufacturer that had established a similiar American business and registered its trademarks in the United States. Later, the French manufacturer sold its American business and trademarks in “Java” face powder to the plaintiff. The defendant purchased the powder from European distributors of “Java” and resold it in the United States in the manufacturer’s boxes.

The district court found that the plaintiff had built up the business in the United States and had the right to the benefit of its goodwill.(129) The defendant’s mark was genuine only “in the sense that it was not spurious at the place of origin, and that no change had been made since it had been sold.”(130) Recognizing the need to protect the plaintiff’s trademark goodwill and its exclusive ownership of the U.S. mark, the court nonetheless ruled that the defendant’s mark on the imported goods was not genuine as a matter of law.

Relying on Apollinaris and Gretsch, the Second Circuit reversed, holding the defendant’s products had trademarks that truly indicated their origin.(131) Just as Apollinaris found no trademark infringement from defendant’s sale of genuine water and Gretsch found no infringement by the importation of “genuine article(s) identified by trademark,” by the court stated, “if the goods sold are the genuine goods covered by the trademark, the rights of the owner of the trademark are not infringed.”(132)

Apparently discontent with the Second Circuit’s opinion in Katzel, Congress enacted the Genuine Goods Exclusion Act of 1922 (Section 526 of the Tariff Act).(133) In the following year, however, the Supreme Court reversed the Second Circuit in Katzel,(134) finding a trademark infringement. The Supreme Court recognized that the French manufacturer was banned by its agreement with the plaintiff from selling its trademarked goods in the United States. The Court extended this restriction to those buying the trademarked goods from the manufacturer. The manufacturer, through sale of its goods, could not convey its “goods free from the restrictions to which [it was] subject.”(135) The European buyers of the goods must recognize that “ownership of the goods does not carry the right to sell them with a specific mark.”(136) Indeed, “it does not necessarily carry the right to sell them at all in a given place.”(137) One place where the foreign buyers were precluded from resale was in the United States because the plaintiff’s goodwill and reputation in the U.S. trademark precluded entry. It was not accurate to say the trademark was “that of the French house and truly indicates the origin of the goods.”(138) Instead, the Court said,”[I]t is the trademark of the plaintiff only in the United States and indicates in law, and, it is found, by public understanding that the goods come from the plaintiff although not made by it.”(139) The trademark had been sold to the plaintiff and “could only be sold with the goodwill of the business that the plaintiff bought.”(140) The plaintiff’s U.S. trademark monopoly included the right to protect its trademark goodwill by enjoining others from importing the genuinely trademarked goods.

Later that year, Bourgeois & Co. sued Aldridge, a Customs official, seeking an injunction to prohibit entry of genuine trademarked goods.(141) The suit was premised on section 27 of the 1905 Trademark Act that required Customs to exclude goods that “copy or simulate” the registered trademark. The district court denied the plaintiff’s motion to enjoin the Customs Office from allowing entry of the goods. On appeal, the Second Circuit certified two questions to the Supreme Court.(142) The first question asked whether the defendant’s goods infringed the plaintiff’s trademark. The second asked whether section 27 of the 1905 Act required Customs to exclude the genuine goods. A one sentence per curiam opinion of the Court answered both questions “in the affirmative, upon the authority Bourjois & Co. v. Katzet, the defendant not objecting.”(143) Thus, while the lower court determined that the imported genuine goods bore a trademark that correctly identified them and, therefore, did not “copy or simulate,” the Supreme Court held that genuine trademarked goods from abroad bearing a trademark owned by a U.S. firm “copy or simulate” the registered mark in violation of trademark law.

There is considerable dispute over the handling of the Katzel and Aldridge decisions. There are those who contend that the Supreme Court in Katzet and Aldridge limited the exhaustion doctrine by confining its application to national borders.(144) they contend that the “territorial principle” supplanted the universality principle in United States law: that trademark rights, such as privilege to resell trademark goods, do not run across national borders and thereby exhaust the trademark owners’ rights in the import country. A domestic trademark owner’s goodwill is a protectable interest prohibiting the importation and resale of goods with identical trademarks genuinely imprinted abroad. Since this view is disputed by those limiting the its factual pattern, subsequent courts and meaning of Katzel to its factual pattern, subsequent courts and administrative agencies in cases involving importation of genuine goods have had considerable difficulty discerning the rules announced in Katzel and Aldridge.

Extending Katzel

In the early 1980’s, several lower courts expressed opinions that extended the trademark protection of Katzel and Aldridge. These decisions were largely premised on three judicial conclusions: recognition of (1) the “territorial” principle, (2) the goodwill theory of trademark, and (3) the insignificance of the mere relatedness of the foreign and U.S. trademark owners.

In 1982, Bell and Howell: Mamiya Co. (BHMC) brought suit against Masel Supply Company, which imported gray market Mamiya cameras.(145) BHMC sought a preliminary injunction under the Tariff and Lanham Acts. The Japanese mark owner and parent company, Mamiya, held only seven percent of BHMC’s stock and exercised no control over the plaintiff’s daily operations. The district court in New York concluded that the Japanese parent’s stock ownership of the U.S. corporation owning the U.S. trademark did not prevent trademark protection for the U.S. trademark owner.(146)

The Bell and Howell court was willing to tolerate some “relatedness” of the foreign and U.S. trademark owners. It rejected the Guerlain court’s conclusion that trademark goodwill of U.S. companies deserved no legal protection against imports from foreign parent companies.(147) Guerlain rejected trademark protection because the court feared antitrust violations through the assertion of trademark infringement actions. The district court judged Guerlain to be based on flawed reasoning that should not serve as a basis for narrowing the scope of Katzel to instances in which the American trademark owner is unrelated to the foreign producer.

Perhaps because of this relationship between the Japanese and U.S. distributor, the court buttressed its holding by interpreting Katzel as (1) adopting the principle of territoriality and (2) establishing the protection of trademark goodwill as its underlying rationale.(148) So interpreted, Katzel would stand as authority to protect any findings of distinct domestic goodwill in a U.S. trademark. Since BHMC was found to be the legitimate owner of the U.S. trademark and of the U.S. business (goodwill) of selling Mamiya goods, the court ruled BHMC was entitled to the preliminary injunction under section 32 of the Lanham Act to protect its trademark from the importation of “confusing” trademarked goods of the gray importer.(149)

The Second Circuit vacated the preliminary injunction issued by the district court.(150) While the district court concluded that “a substantial likelihood of confusion” existed, the appellate court judged that there was “an absence of factual support” for that conclusion as related to the “irreparable injury” requirement for a preliminary injunction.(151) The appellate court thought that irreparable injury might not exist because there appeared to be “little confusion, if any, as to the origin of the goods and no significant likelihood of damages to BHMC’s reputation. . . .”(152) Since Masel’s goods had a common origin of manufacture with BHMC’s goods, it had not been shown that Masel’s goods were inferior to those sold by BHMC. Thus, the court was unwilling to conclude that there was any significant likelihood of injury to BHMC’s reputation.

By reversing on the ground of an inadequate showing for the preliminary injunction, the court did not discuss the merits of the plaintiff’s contentions of trademark infringement. The lower court adopted the principles of territoriality and of trademark protection for distinct domestic trademark goodwill. It found the domestic goodwill in the trademark was infringed by the importation of gray goods that caused “confusion” in violation of section 32 of the Lanham Act. This theory of trademark infringement was not expressly rejected by the appellate court.

One year later, the same plaintiff, albeit under a changed name, brought a similar action against a new defendant. In Osawa v. B & H Photo,(153) another district court in New York ordered a preliminary injunction barring defendants from importing Mamiya-marked products. The court concluded that irreparable harm was shown this time (1) by a drastic decline in the plaintiff s sales, (2) by the defendant’s free ride on plaintiff’s publicity, (3) by widespread disaffection among authorized dealers because of the gray market price competition, and (4) by the plaintiff’s having to perform warranty repairs or honor rebate offers on gray market cameras.(154)

Furthermore, the district court found a likelihood of success on the merits, meaning a likelihood of trademark infringement.(155) Finding trademark infringement on the same grounds expressed by the Bell and Howell court,(156) it maintained that the Katzel case created the principle of territoriality and recognized the proper lawful function of trademark to symbolize the domestic goodwill of the domestic mark holder rather than merely to specify the origin or manufacturer of the good. Then, on the basis of factually distinct goodwill in the United States, the court ruled that the plaintiff’s goodwill symbolized by its trademark was a protectable interest because the imported gray goods created “confusion” in violation of section 32 of the Lanham Act.

The court also rejected Guerlain’s analysis that antitrust problems should be remedied by what the court called Guerlain’s illogical misapplication of the trademark law.(157) Instead, the court asserted that antitrust problems should be attacked directly by antitrust law. Similarly, the court found that mere relatedness of the foreign and U.S. trademark owner was no logical basis for limiting Katzel.(158)

In 1984, the United States International Trade Commission, in In re Certain Alkaline Batteries,(159) went further than both Bell and Howell and Osawa. The commission ruled that Duracell could obtain an order excluding importation of gray market batteries made by Duracell’s Belgium subsidiary. Like the courts in Bell and Howell and Osawa, the U.S. International Trade Commission adopted the territoriality principle. It ruled that the territoriality doctrine recognized a trademark as having separate legal existence under the laws of each country. The commission then went further when it said trademark ownership, by itself, implies the right to exclude others from its use. No separate U.S. goodwill in the U.S. trademark was required, as in Bell and Howell and Osawa. Thus, it judged that the imported goods bearing trademarks copied the U. S. trademark in violation of section 42 of the Lanham Act.(160)

The International Trade Commission was willing to ban gray goods, under section 42 of the Lanham Act, even though such imports were produced by a foreign affiliate of a U.S. trademark owner. The commission ruled any affiliation to be irrelevant because the mere ownership of the U.S. trademark provided sufficient basis to find the foreign import to be a prohibited “copy” under section 42.(161)

The conclusions of the U.S. International Trade Commission were overturned by President Reagan, who had the authority to review the Commission’s order.(162) The President stated that the Commission’s interpretation of section 42 of the Lanham Act was “at odds with [Customs Service’s] long standing regulatory interpretation.”(163) Since the President’s Cabinet was then studying the gray market importation problem with the view to establishing a uniform policy, the President did not want the commission’s order to stand prior to the completion of the administration study.(164)

The commission’s view had gone further than Bell and Howell and Osawa. The commission found the foreign trademark infringed simply by entering the country and competing with the American trademark and depriving the U. S. mark owner of its profits. Under this view, section 42 protects the trademark investment regardless of proof of consumer confusion or relationship between the U.S. and foreign trademark owners. This amounts to a statement that gray market goods per se violate the trademark laws.

The district court opinions in Bell and Howell and Osawa required proof of a factually distinct domestic goodwill by the U.S. trademark owner in order to have a protectable interest against gray market imports. The district courts did not require the U.S. trademark owner to have purchased the mark outright as had been done in the Katzel situation. Nor did the courts rule that a close relationship to the foreign trademark owner precluded trademark protection. Rather, the relationship was not to be one whereby the foreign firm’s control was excessive. The relationships between the foreign and domestic trademark owners in Bell and Howell and Osawa were not found to be the type where the foreign firm possessed dominating control over the U.S. trademark owner. Instead, the courts found the U.S. trademark owner to be an independent company, even though it was related to the foreign trademark owner.

The district court decision in Osawa was not reviewed by an appellate court. The Bell and Howell decision was reversed for failure of sufficient proof to warrant a preliminary injunction, but the lower court’s discussion of the trademark infringement issues was not specifically overruled. Thus, the district court opinions about trademark infringement in Bell and Howell and Osawa have not been specifically disapproved. Their holdings state the propositions that Katzel established the principle of territoriality and adopted the distinct domestic goodwill theory of trademark. Hence, these district courts, by focusing on the distinct domestic goodwill of the U.S. trademark owner, found the gray imports to have a different, nondomestic goodwill supporting the identical trademark. The gray goods were viewed as creating consumer confusion and mistake as to which entity stood behind the quality assertions of the trademark. Hence, confusion of which entity stood behind the trademark, rather than confusion of production origin, was judged sufficient to violate the Lanham Act’s section 32 standard prohibiting “confusion.”

These district courts also ruled that mere relationship of the foreign and U.S. trademark owners does not automatically preclude a finding of trademark infringement. Rather, the U.S. firm is ruled “independent” as in Katzel, not because it purchased the trademark, but because it established a factually distinct domestic goodwill in the trademark, and its relationship with the foreign trademark owner did not amount to its being dominated or controlled by the foreign trademark owner.

Limiting Katzel

A different line of authorities has developed that rejects the district court holdings of Bell and Howell and Osawa. The United States Courts of Appeal for the Second, Third, and Ninth Circuits have limited Katzel and refused to extend its protection.(165) They have refused to adopt any broad territoriality principle or recognize any goodwill theory of trademark beyond those suggested in the factual pattern of Katzel.

In 1986, the Second Circuit Court refused to expand Katzel in Olympus Corp. v. United States.166 Olympus is a wholly owned subsidiary of Olympus Optical, a Japanese corporation that manufactures Olympus-brand products, including cameras and lenses. Olympus is the exclusive distributor of Olympus Opticals’ Japanese-manufactured goods in the United States, and it owns the rights in this country to the Olympus trademark. When Olympus-brand goods were imported by gray marketers, the Customs Service refused to bar the importation because of the “common control” of the Japanese parent, Olympus Optical, and the U.S. subsidiary, Olympus, over the trademark goods. Olympus sought declaratory and injunctive relief declaring the Customs Service regulations invalid and a finding that the gray market goods infringed Olympus’ trademark. The district court refused to issue the requested order and held that the plaintiff failed to state a claim under section 42 of the Lanham Act.(167)

The Second Circuit affirmed the district court’s holding that the Customs Service’s regulations were valid(168) and also upheld the district court’s dismissal of Olympus’s claim under section 42 of the Lanham Act. The court interpreted the “plain language” of section 42 of the Lanham Act as not barring importation of genuine goods because such goods do not “copy or simulate” a U.S. trademark.)169) Furthermore, the court refused to apply Aldridge(170) to this case. The court limited Aldridge by characterizing it as a “one sentence per curiam opinion announcing a decision, to which the opposing party did not object, based on the reasoning of a three page opinion in . . . Katzel, a case influenced by equities not present here.”(171) Then, the court concluded that “Katzel had limited application to any but its own special facts.”(172)

By rejecting any expansive interpretation of Katzel in relation to section 42 of the Lanham Act, the Second Circuit cast doubt on any continuing validity of the district court opinions in Bell and Howell and Osawa. However, those decisions were based on the “confusion” standard of section 32 of the Lanham Act, while the Olympus decision was focused on the “copy or simulation” standard of section 42 of the Lanham Act. Thus, while Olympus closed the door in the Second Circuit on any expansive interpretations of Katzel in relation to section 42, it did not specifically deal with the expansive doctrines of Bell and Howell and Osawa under section 32.

A year later the Ninth Circuit Court agreed with the Second Circuit’s Olympus decision. In NEC Electronics v. Cal Circuit Abco,(173) it faced a gray market situation involving a foreign parent and U.S. subsidiary seeking to bar parallel imports. NEC-Japan is a manufacturer of computer chips. NEC-USA is a wholly owned subsidiary that is controlled by the parent, NEC-Japan. In 1983, NEC-Japan assigned all rights to the “NEC” mark in the United States to NEC-USA. Defendant ABCO bought gray market computer chips from a foreign source and imported them in direct competition with NEC-USA. NEC-USA sued ABCO for trademark infringement under section 32 of the Lanham Act.(174) The district court found that some purchasers from ABCO mistakenly thought their chips were protected by NEC-USA’s servicing and warranties. Based on consumer confusion of this sort, the district court found trademark infringement and granted NEC-USA’s motion for a preliminary injunction.(175)

The appellate court reversed the preliminary injunction against importation.(176) The Ninth Circuit asserted that trademark law generally does not reach the sale of genuine goods bearing a true mark: once a trademark owner sells the product, the buyer ordinarily may resell the product under the original mark without incurring any trademark law liability. The court reasoned that trademark law is designed to prevent sellers from confusing or deceiving consumers about the origin or make of a product. Such confusion ordinarily does not exist when a genuine article bearing a true mark is sold. These principles of trademark law, the court said, would have decided this case were it not for the Supreme Court’s decision in Katzel.(177)

While NEC-USA had argued that Katzel’s holding bars the importation of gray goods, the Ninth Circuit Court disagreed. The appellate court said there are two rationales for the holding in Katzel.(178) First, the American company that acquired the mark had made an arm’s length contract with the manufacturer that was clearly intended to prohibit the manufacturer from selling its goods directly in this country. The foreign manufacturer could not have sold its goods under the old mark in competition with the plaintiff in the United States. Thus, the Court would not permit the manufacturer to “evade” this restriction by selling to middlemen abroad for sale in the United States.

The second rationale of the Katzel decision, according to the Ninth Circuit, was that the American trademark owner obtained complete control over and responsibility for the quality of the goods sold under the purchased mark.(179) The purchasers had become the true source of the trademarked goods in the United States, and the value of the purchaser’s trademark would have been destroyed by the importation of foreign-purchased goods whose quality was beyond its control.

Based on these rationales, the Ninth Circuit concluded that there must be both a purchase of the U.S. trademark rights and control by the U.S. purchaser over the quality of the trademarked goods to be sold for Katzel to be controlling.(180) Both of these rationales announced by the Ninth Circuit presuppose the American owner’s “real independence” from the foreign manufacturer. The Ninth Circuit supported this conclusion by citing the Second Circuit’s decision in Olympus which involved a foreign parent of a U.S. subsidiary. The Second Circuit held that Katzel did not apply in the foreign parent-U.S. subsidiary situation and that Katzel should be limited to its “special facts.” Thus, the Ninth Circuit concluded that if the American trademark owner is a wholly owned and controlled subsidiary of the foreign manufacturer, neither of the Katzel rationales applies. Just as Olympus had concluded that section 42 of the Lanham Act barring importation of goods that “copy or simulate” a trademark did not apply to genuine goods except in cases presenting the same “equities” as Katzel, the Ninth Circuit thought that this conclusion was correct for section 32 of the Lanham Act as well.(181)

In 1989, the Third Circuit in Weil Ceramics and Glass, Inc. v. Dash(182) joined the Second and Ninth Circuits in restricting Katzel. The district court had upheld a trademark infringement action on the basis of separate domestic goodwill in the U.S. trademark, even though the U.S. trademark owner was related to the foreign trademark owner-manufacturer.(183) The district court asserted that the domestic trademark owner’s independence, as in Katzel, did not depend on its relationship with a foreign entity but rather upon whether there was a distinct goodwill for the trademark product in the United States. Then, on the basis of consumer confusion between the domestic trademark product and the gray market product, the district court held that the gray importer infringed the domestic mark in violation of section 42 of the Lanham Act.(184)

The Third Circuit, however, reversed the district court’s conclusion. The appellate court stated that the protection afforded by sections 42 and 32 of the Lanham Act was inapplicable because of the relationship that Weil had with its foreign parent.(185) The Third Circuit Court concluded that Weil’s arguments of trademark infringement were premised on two basic notions.(186) Weil asserted, first, that it owned the United States trademark independently of its foreign parent and second, pursuant to the territoriality theory attributed to Katzel, that it was entitled to full trademark protection. The district court accepted Weil’s arguments and interpreted Katzel as adopting the territoriality principle that recognizes separate existence of a trademark in each territory (country).(187) However, the Third Circuit ruled that Katzel did not establish a broad “territoriality” theory applicable to every instance in which a domestic company acquires the U.S. trademark for a foreign manufactured good. Rather, the appellate court read Katzel as “creating an exception to the general application of trademark law” in order to protect certain domestic trademark holders, those U.S. trademark holders that are independent of the foreign manufacturer and in control of the quality of the U.S. trademark product.(188) Since Weil was not independent of the foreign manufacturer or in control of the quality of the product, it was not entitled to the Katzel “exception” to the general principles of trademark law.

The court supported its interpretation of Katzel by citing the Ninth Circuit’s decision in NEC Electronics, which held that Katzel requires “real independence” of the American trademark owner.(189) The Third Circuit also thought that its decision was consonant with K mart, which identified the Katzel situation as a Case 1 scenario that deserved import protection.(190) K mart did not extend Katzel to Case 2 situations involving common control.(191) As K mart limited section 526 of the Tariff Act to independent domestic trademark owners, the Third Circuit decided that the same K mart reasoning required that the provisions of section 42 and section 32 of the Lanham Act should be limited, like Katzel, to independent trademark owners.(192)

The court of appeals also rejected Weil’s argument that the territoriality principle attributed to Katzel caused mere registration of a trademark to create a distinctive trademark in each territory.(193) Weil bad argued that its registration of the foreign trademark in the United States should be viewed as having created a trademark in the United States that is distinct from any other mark, even distinct from the identical mark placed by the same manufacturer on goods produced abroad. Weil contended, therefore, that its trademark was “copied” by any unauthorized use, including importation of genuine gray goods.(194) Since the Third Circuit rejected the conclusion that Katzel extended the Trademark Act protection beyond the Katzel factual pattern, the court did not deal with the “strained interpretation of the language of Section 42 or Section 32” that Weil advocated.(195) Instead, it ruled that the plain meaning of section 32 and section 42 of the Lanham Act was not ambiguous. It found section 42’s “copy” or “simulate” language to have ordinary meanings that are commonly used to refer to items that resemble but are not themselves the original or genuine artifacts.(196) The court was convinced that Congress understood the commonly held meaning of these terms and intended to apply them literally. Hence, it agreed with the Ninth Circuit that “trademark law generally does not reach the sale of genuine goods bearing a true mark even though such sale is without the owner’s consent.”

The Third Circuit also looked to the design of the trademark statute as a whole and felt compelled to find no trademark infringement.(198) The court determined that Congress sought to foster two broad policy goals in the Trademark Act: (1) protection against consumer deception resulting from deceptive imitation of the trademark and (2) protection of the trademark holder’s investment in goodwill that has been generated by advertisements and quality from imitative goods over which the trademark holder has no control of quality.(199) According to the court, neither of these policy goals is undermined by the importation of genuine goods.(200) Consumers who purchase gray imported products get precisely what they believe they are purchasing. Weil’s investment in and sponsorship of its trademark is not adversely affected because the goodwill that stands behind its product is not diminished by any association with goods of lesser quality. The only “injury” was the lack of compensation for the benefit that its advertisement and promotion of the trademark conferred upon the gray dealer, but the remedy for such free riding is not found in trademark laws.(201)

Thus, the Second, Ninth, and Third Circuit Courts have limited Katzel. Only independent (not foreign affiliated) U.S. trademark owners with factually distinct U.S. goodwill and control over product quality are eligible for protection. The courts have not adopted any broad territoriality principle or recognized any goodwill or sponsorship theories of trademark that would allow multinational firms to assert trademark rights to divide the world market.(202)

Non-Genuine Goods

Another series of gray market cases deal with “nongenuine” imported goods. The goods are considered nongenuine, not because the trademark itself is false, but because the product is different from the product sold under the same trademark in the United States. Several cases have held that “nongenuine” gray market goods that are marketed under the same trademark create consumer confusion and, therefore, infringe the U.S. trademark. Furthermore, affiliation of the foreign and American producers using the same trademarks in nongenuine goods cases is judged irrelevant to the conclusion of infringement.

The United States Court of Appeals for the Second Circuit made the seminal ruling in nongenuine cases in Original Appalachian Artworks v. Granada Electronics(203) in 1987. Original Appalachian Artworks, Inc. (Artworks) manufactured and licensed the Cabbage Patch Kids dolls that were sold through stores called “adoption centers.” Purchasers of the dolls received “birth certificates” and adoption “papers” to be filled out by the new owner and returned to Artworks. Artworks then sent a birthday card to the adopting “parent.” This adoption process was found by the court to be an “important element” of the mystique of the dolls that had substantially contributed to their commercial success.

Artworks brought an action under section 32 of the Lanham Act against Granada Electronics which imported Cabbage Patch Kids dolls that had been made in Spain by Jesmar under a license from Artworks. The district court found that Jesmar’s Cabbage Patch Kids dolls (which were not intended for U.S. markets) were materially different from the plaintiff’s dolls sold in the United States because the adoption papers were in Spanish. The plaintiff, Artworks, was unable or unwilling to process Jesmar’s adoption papers. Therefore, the district court concluded that, on the basis of numerous letters from parents and child doll-owners, the sale in the United States of Spanish language dolls with prominent English language trademarks caused the public to confuse the Spanish dolls for the U.S. trademarked dolls.(204) This finding that the goods was materially different goods were upheld by the appellate court, which also sustained the trademark infringement action against the importer, Granada Electronics.

In defense, Granada pointed out that Artworks licensed Jesmar to produce the dolls. Artworks owned and controlled the trademark on Jesmar Cabbage Patch Kids dolls. Hence, Granada argued that Artwork’s control over the trademark goods produced by Jesmar precluded any finding of infringement because Artworks cannot be damaged by the sales of its own goods. The appellate court admitted that this argument might have some force in cases in which the imported goods were identical to the domestic goods. Since the goods in this case were not identical and were confusingly different, however, the fact that Artworks was a single entity that owned the trademark worldwide was not dispositive.(205)

Another appellate court decision on “non-genuine” imports is Lever Brothers Co. v. United States.(206) Lever UK was an English corporation affiliated with Lever US. Both Lever US and Lever UK manufactured a soap under the Shield trademark and a liquid dish washing detergent under the Sunlight trademark. The British and American soaps contained different chemical ingredients and possessed differing perfumes and colorants. Likewise, UK Sunlight was designed for water with higher mineral content than is generally found in the United States, while UK Sunlight would not perform well in the soft water typically found in American metropolitan areas.

Third parties imported UK Shield and UK Sunlight into the United States without authorization by Lever US. The Customs Service refused to halt the importation because the trademarks were used abroad by an affiliate of Lever US.(207) The Service regarded the physical differences in the product and the domestic markholder’s non-consent to importation as irrelevant when affiliation between foreign and American producers existed.(208)

Lever’s claim was based on section 42 of the Lanham Act which prohibits imported merchandise that shall “copy or simulate” a registered trademark. Lever’s contention was that when affiliated domestic and foreign firms’ goods bear the same trademark but are different in physical content the foreign products “copy or simulate” the domestic trademark. The district court essentially agreed with the Customs Service’s interpretation of section 42 and denied Lever’s request.(209)

The United States Court of Appeals for the District of Columbia reversed the lower court by tentatively concluding that the Customs Service’s construction of section 42 defeats the section’s purpose and is therefore contrary to its intent.(210) The court began its analysis by asserting that the plain language of the Lanham Act undeniably bespeaks an intention to protect domestic trademark holders from foreign competitors who seek a free ride on the goodwill of domestic trademarks.(211) The court cited Katzel and Aldridge as demonstrating the Supreme Court’s view that trademark law was intended to protect a manufacturer’s reputation and goodwill and to prevent confusion among consumers. Moreover, the court stated Katzel and Aldridge created the principle of trademark territoriality.(212)

The court recognized that K mart held the affiliate exemption of the Customs Service regulations did not violate section 526 of the Tariff Act. However, the court pointed out that the Supreme Court in K mart did not reach the question of the exemption’s validity under section 42 of the Lanham Act. Thus, K mart was judged not to be authority for determination of the Lanham Act issue.(213)

To support the affiliate exemption, the Customs Service cited many cases.(214) However, the court of appeals determined that those cases involved “parallel importation” of identical goods. Here, the gray goods bore a valid foreign trademark and were imported to compete against domestically produced goods that were physically different from the foreign goods. The court noted that in such situations, other courts had indicated a readiness to find infringement, citing Original Appalachian Artworks.(215)

While Artworks rested on section 32 of the Lanham Act requiring “likelihood of confusion” rather than section 42 requiring a “copy or simulation”, the D.C. Circuit Court thought that the element of consumer confusion found in Artworks similarly existed in this case and was “equally relevant under section 42.”(216) Thus, the court provisionally ruled that section 42 was aimed at preventing consumer confusion resulting from the importation of nongenuine goods imprinted with identical trademarks.

The court also stated that the affiliation between the foreign and U.S. producers in no way reduced the probability of consumer confusion resulting from different goods with identical trademarks.(217) While Artworks dealt with goods produced by a foreign licensee, rather than an affiliate, the distinction between producing by license and producing by affiliation was inconsequential. Artworks did not infer consent to importation because of the license to produce abroad, and the D.C. Circuit Court was not willing to infer consent to importation from mere affiliation.(218)

The Second circuit and the District of Columbia circuit courts seem to agree that if the imported goods are physically different from the domestically produced goods, the use of identical marks will likely be confusing to consumers. Since the likelihood of consumer confusion is independent of any affiliation between the producers, the appellate courts indicated that affiliation is not controlling. Thus, Artworks and Lever in combination assert that “nongenuine” imported goods with marks identical to U.S. marks on U.S. produced goods are likely to confuse consumers, which warrants a finding of infringement under Section 32 (Artworks) and an injunction under Section 42 to the Customs Service to ban such imports (Lever). Furthermore, affiliation of foreign and American producers using the same trademarks is judged irrelevant to these conclusions.

The D.C. Circuit opinion has implications beyond its holding that non-genuine goods can be banned under Section 42 of the Lanham Act. In dicta, the court also indicated that Katzel adopted the territoriality principle and asserted that trademark law protected the trademark owner’s reputation and goodwill.(219) These conclusions lay a foundation for the D.C. Circuit Court in future cases to extend Katzel’s protection of trademark owners to ban even genuine goods that may interfere with the U.S. trademark owner’s goodwill. If the court finds that the genuine goods create confusion that interferes with the U.S. trademark owner’s goodwill, then affiliation of foreign and American trademark owners becomes irrelevant under the Lever reasoning. Thus, the dicta of the Lever decision seems to put the D.C. Circuit on a course to create a “conflict” with the holdings of the other circuit courts concerning genuine goods.

CONCLUSIONS AND SUGGESTIONS

In the late 1980’s, it appeared that the appellate courts were settling the tariff and trademark issues in gray market litigation. However, recent judicial decisions indicate otherwise. There are unanswered questions from the K mart case, and the recent opinion of the D.C. Circuit in Lever has resurrected arguments first appearing in the district court opinions of the Bell and Howell and Osawa cases. Continued litigation likely will not develop a coherent policy dealing with the gray market controversy. Legislation is needed to not only determine a coherent policy for the gray market issue, but also to forestall the potential judicial expansion of trademark law into a legal mechanism for banning import of trademarked gray goods. Trademark law would then become a means of achieving legal allocations of the world market into national segments in contradiction of antitrust principles and free global markets. Instead, Congress should overturn Katzel and Aldridge and clearly declare the free importation of gray goods. But to prevent consumer confusion that may result from the importation of gray goods with physical differences, Congress should simultaneously enact labeling requirements for gray imports that possess significant variations inequality from domestic trademarked goods.

Section 526 after K mart

Section 526 of the Tariff Act provides a ban on importation of foreign-produced merchandise that bears a trademark “owned by” a U.S. firm. K mart Corp. v. Cartier has established that section 526 permits a ban on genuine trademarked goods when the U.S. firm is not affiliated with foreign entities owning the foreign trademark and producing the imported trademarked goods.(220) An independent (nonaffiliated) U.S. trademark owner, whether purchasing or acquiring the foreign mark by assignment,(221) may cause foreign-produced goods with identical marks to be banned from importation. This ban on importation may also be exercised by an independent U.S. trademark owner who licenses the imprint of the trademark on foreign-produced goods.(222) Thus, only foreign produced goods of affiliates of U.S. trademark owners re denied the import ban of section 526.(223) Affiliated entities are denied the import ban by the Customs Service and, according to some courts, are also denied the right to bring private actions under section 526(c) to ban imports.(224)

The Customs Service’s affiliate exception permits importation when the foreign and U.S. trademark owners are affiliated, regardless of physical differences between the imported and U.S. products.(225) The Service does not recognize any argument of nongenuineness of the import as a result of any physical dissimilarities of the imported product compared with the U.S. product. Thus, under Customs Service regulations, affiliated companies cannot obtain a ban on genuine trademarked goods.

The affiliate exception to section 526’s ban was created by the Customs Service, apparently based on its interpretation of Katzel and the antitrust law.(226) Though the K mart decision permitted the affiliate exception, the Supreme Court did not review or establish any coherent policy rationale for its judicially permitted ban on Case 1 (Katzel) and Case 3 (licensing) imports.

One may question the K mart Court’s failure to explain why U.S. trademark owners in Case 1 (Katzel situation) should be protected from gray imports when trademark owners in Case 2 (affiliates) should not.(227) While Justice Brennan argued that the equities in the two cases are different, his reasoning was not persuasive. He contended that the Katzel holder of a trademark could “lose the full benefit of its bargain because of gray market interference.”(228) In contrast, he asserted that affiliates do not have the same sort of “investment at stake.”(229) These assertions lack convincing support because American trademark holders, whether affiliated with foreign firms or not, normally spend considerable sums of money developing goodwill for the U.S. mark.(230) Yet they risk, like the Katzel holder of a trademark, the “full benefit” of these expenditures “because of gray market interference.” Brennan’s further assertion that the U.S. trademark purchaser in Case 1 has no direct control over gray market imports while U.S. trademark owners in Case 2 can take steps to have their foreign affiliates stop imports to the United States(231) is not factually supported. The bulk of gray market imports are “attributable to third parties that are unaffiliated with either the manufacturer or the trademark holder.”(232) Trademark owners cannot “control” the import decisions of these third parties. Furthermore, the laws of most other nations prohibit any foreign affiliate from using private restrictions on exports from their shores.(233) Thus, Brennan’s efforts to justify the Katzel decision were not convincing, and the Court as a whole did not directly address the justifications for the Katzel decision.

The K mart Court also failed to consider the underlying rationale for the Customs Service’s decision to add the affiliated companies and authorized use exceptions in 1972. The historical evidence suggests that the Service was attempting to accommodate section 526 with its interpretation of the Katzel decision and its view of the existing antitrust laws. Yet, as previously noted, the Court did not review the Katzel decision. Nor was a judicial review of the antitrust rationale conducted. Surely an antitrust review would have noted that the per se rules of antitrust against intrabrand nonprice restraints in the late sixties and early seventies had been replaced in the late seventies by the more lenient “rule of reason.”(234) Hence, the antitrust basis for the Customs Service’s regulation regarding affiliates may have been eroded.

The Court held that the Customs Service could not permit importation of goods produced abroad by a licensee of an American company if there is no control affiliation between the licensor and licensee.(235) Yet, trademark law requires the licensor to ensure the quality of goods produced by the licensee or lose its mark.(236) Thus, the American licensor may exercise no less control over the quality of the foreign goods produced pursuant to license than an American firm exercises over goods produced abroad by its subsidiary or division. Why should an American firm be protected from gray market imports of its foreign manufactured goods if it licenses use of the mark abroad but lose that protection if it incorporates a foreign subsidiary or creates a foreign division to produce the same goods abroad? It does not seem appropriate that the form of exercising quality control should change the legal result. Yet, by focusing only on issues of statutory construction, the K mart Court failed to deal with policy questions or develop a coherent policy rationale.

There is another question not answered in K mart. The Customs Service regulations were created under the authority of both section 526 of the Tariff Act and section 42 of the Lanham Act. Yet, the Court held valid or invalid certain provisions of the Customs Service’s regulations on the basis of its interpretation of section 526 of the Tariff Act. Whether those provisions validated under section 526 also survive under section 42 of the Lanham Act was not answered. The licensing regulation held invalid in K mart because it was not a reasonable interpretation under section 526 of the Tariff Act could possibly be interpreted as “reasonable” and valid under section 42 of the Lanham Act. The Customs Service has attempted to “resolve any remaining ambiguity” and maintain its “longstanding practice of

interpreting both underlying statutory provisions in tandem” by revising its regulations to eliminate the “licensing” provision in its entirety.(237) But the question of whether the “common control” provisions authorizing gray imports held valid under section 526 of the Tariff Act are similarly valid under section 42 of the Lanham Act is not settled. The Third Circuit in Weil Ceramics held the affiliation exception to be a valid interpretation of section 42 of the Lanham Act.(238) However, the D.C. Circuit Court’s decision in Lever tentatively declared that the Customs Service’s “common control” regulations were invalid under section 42 of the Lanham Act.(239) If this conclusion is ultimately upheld by the D.C. Circuit, its ruling will create a ban of all gray market imports and conflict with the decisions of other circuit courts. If so, the Supreme Court may again face questions about the validity of the Customs Service’s regulations, but this time the regulations will be challenged under section 42 of the Lanham Act. It is clear that K mart answered few questions about the international gray market controversy. The unanswered questions will fuel continued debate and litigation in gray market situations.

Section 32 and 42 of the Lanham Act

Traditional trademark principles suggest a clear interpretation of sections 32 and 42 of the Lanham Act. An infringement of a trademark in violation of section 32 involves the use of a mark likely to confuse consumers. Genuinely trademarked goods do not confuse the consumers in violation of the section. The consumer is getting genuine goods and the imported goods contain the quality that the trademark promises. Foreign goods that use nongenuine marks that “copy or simulate” a U.S. trademark violate section 42 and warrant a ban on such imports. Traditionally, however, imported trademarked goods are not copies or simulations in violation of section 42 if the goods are genuine and bear the trademark rightfully. Under this interpretation, section 42 only bans counterfeit goods.

However, traditional trademark principles are complicated as a result of the Katzel and Aldridge decisions. There have been contradictory interpretations of Katzel and Aldridge in modern cases involving gray market imports,(240) although the Second, Third and Ninth Circuits seemed to be establishing a definitive interpretation of trademark law in relation to genuine gray market imports of trademarked goods.(241)

These appellate courts have rejected Bell and Howell and Osawa’s expansive interpretation of Katzel. These lower courts wanted to interpret Katzel as adopting the territoriality principle and establishing protection of trademark goodwill as the primary focus of trademark law. They would have expanded Katzel’s protection to all U.S. trademark owners with domestic trademark goodwill, whether affiliated with foreign trademark owners or not. Yet, the appellate courts rejected the notion that Katzel’s limited territoriality principle deems all identical foreign trademarks to be infringements of U.S. trademarks upon entry into the U.S. market. They also have not accepted arguments that Katzel established protection of U.S. trademark goodwill to the extent that imported genuine goods automatically constitute an infringement of the U.S. trademark owner’s goodwill.

Instead, the appellate courts have limited Katzel’s “territoriality” principle and “trademark goodwill protection” to the factual pattern of the Katzel case. They have not only emphasized the requirement for “independence” of the U.S. trademark owner but also have required that the U.S. trademark owner control the quality of the product under the trademark.(242) If the U.S. trademark owner does not control the quality of the trademark product or is not independent of the foreign trademark owner, Katzel’s protection does not extend to the trademark owner. Affiliation of the foreign and U.S. trademark owners precludes any finding of trademark infringement under the authority of Katzel. Thus, trademark law and Katzel have not evolved into an expanded protection for trademark owners from the competition of imported genuine goods bearing identical trademarks. However, the D. C. Circuit court in Lever has issued a preliminary decision to expand trademark protection in contradiction to the Second, Third and Ninth Circuits.(243) A conflict among the circuit courts seems likely in the future.

Another series of appellate court decisions have created a “loophole” to the restrictive interpretation of Katzel. While the Third and Ninth Circuit Courts have held that Katzel cannot be utilized to prohibit entry or to allege infringement against imported goods when the foreign and U.S. trademark owners are affiliated,(244) the Second Circuit in Artworks and the D.C. Circuit in Lever held that the affiliation of the foreign and U.S. trademark owner was irrelevant when the imported goods were “not genuine.”(245) In Artworks, the absence of English instructions in the sale of the imported dolls made the dolls “not genuine.” In Lever, the imported goods had different chemical compositions from the U.S. trademark goods that rendered the import goods “not genuine.” The success of these plaintiffs in gaining import bans, despite their affiliation (or license) with the foreign producer, will undoubtedly be noticed by future plaintiffs.(246) They will surely be able to discern differences in the imported products that suggest that they are “not genuine.”

Deciding cases on the factual conclusions of physical equivalency to determine “genuineness” of the import will introduce still more uncertainty into the outcome of gray market cases. If future plaintiffs are able to introduce “differences” in the product by use of instruction sheets in foreign languages or by variations in chemical composition, then import bans on identically trademarked products will become more prevalent. Indeed, all marketing services rendered by the U.S. trademark owner make the U.S. product different from the bare imported product without such marketing services. If the gray marketer fails to add the same marketing services, some court may find these “differences” as amounting to “nongenuine” goods that should be banned.(247)

Thus, modern cases involving international gray marketing have created wide-ranging results. It seems clear that litigation is not able to develop a coherent policy rationale for dealing with gray market imports.

Selecting Appropriate Policies

Underlying the judicial interpretations of statutes and regulations is the more fundamental question of whether gray trademarked goods should. be banned from importation. Since World War II, the United States has advocated international “free trade.” The U.S. has taken the lead in fashioning the multinational General Agreements on Tariffs and Trade (GATT) that seek to reduce tariffs and other barriers to international trade.(248) But, U.S. advocacy and its future success in continuing to negotiate reductions in trade barriers may be jeopardized by inconsistent trade policies such as erecting “gray market” import bans. The rest of the western industrial countries permit “gray marketing.” They have adopted the “universality” principle that does not recognize the existence of separate national trademark goodwill for the purpose of banning imports.(249) These nations undoubtedly will resent any enlargement of the import ban of section 526 and should be resisted as inconsistent with the post World War II foreign policy of the United States and with the policies of other nations.

Consumer prices are reduced by vigorous international price competition provided by importers of diverted goods.(250) Arbitraging currency exchange rates by importing lower cost goods reduces U.S. wholesale costs that can be passed on to the U.S. consumer at the retail level. Such import arbitrage also dampens exchange rate fluctuations and their disruptive effect on international industries.(251) Public policy, therefore, should encourage arbitrager efficiencies that benefit domestic consumers and lessen the problems of exchange rate fluctuations. Hence, an import ban should be rejected as economically inefficient.

An import ban on gray goods also would conflict with basic antitrust policies. A governmentally assisted ban on intrabrand imports would permit manufacturers to create a division of customers and territories, in practical effect, a division between U.S. customers and the rest of the world. This division would allow manufacturers to control the quantity and price of the product within the United States without the threat of any intrabrand competition from abroad. An import ban on gray goods would permit multinational enterprises to engage in price discrimination among different countries.(252)

Domestically, a manufacturer price discriminating between different distributors or regions of the U.S. could not obtain government aid to prevent diversions of its, trademarked goods from low-priced areas to distributors or retailers in high-priced areas.(253) It is clear that U.S. government policy in relation to domestic diversion of goods is permissive. U.S. policy with respect to international diversion of trademarked goods should be just as permissive.

The closest domestic parallel to a U.S. import ban on foreign goods would be a state government ban on interstate “imports” to the state. Some states in the past attempted to enforce their “fair trade” laws by alleging that out-of-state goods unfairly competed with instate merchants selling at higher “fair trade” prices. Nevertheless, the free trade principles of the Interstate Commerce Clause eliminated state efforts to ban interstate sales.(254) The same principle of free trade should similarly eliminate any national ban on international sales.

While domestic antitrust cases have permitted “reasonable” private agreements between manufacturers and their retailers not to sell (or divert) goods to gray marketers,(255) the government does not assist the enforcement of these private bans on sales to intraband competitors. Yet an import ban would be governmental assistance to effectuate the ban on sales to intraband competitors. A government import ban would be inconsistent with domestic antitrust policy that permits only “reasonable” private efforts to ban diversions.

Intrabrand competition is usually judged to be worthy of preservation unless some consumer benefit, such as increased interbrand competition, is gained by the reduction of intrabrand competition. But, improving interbrand competition cannot be presumed from a ban on intrabrand imports if multinational corporations are involved. Collusion may be just as likely, especially among manufacturers in oligopolistic industry structures.(256) Thus, an outright ban on gray imports is not justified because it would eliminate intrabrand competition without a sufficient probability of increased interbrand competition.

By permitting diversions of goods to unauthorized distributors, U.S. policy favors intrabrand competition even if it involves “free riding.” Consumers who purchase diverted goods are merely demonstrating their preference for lower prices over marketing services provided by authorized distributors. Price competition and consumer choice are basic elements of the market model assumed and encouraged in most U.S. policies. Neither element should be abandoned in the form of a ban on gray imports merely to enhance the rights of trademark owners and the unlikely possibility of increased interbrand competition.(257)

International “gray marketing” or “free trade” plays a substantial role in bringing products to discount stores and ultimately to consumers at lower prices. Eliminating international diversions of goods to discounters will substantially reduce the supply of goods available for price discounting and for alternate marketing outlets selling to consumers, some of which are unlikely to patronize traditional outlets. Consumers willing to accept less marketing services in order to obtain a lower price will be frustrated. Giving up these substantial marketing efficiencies and consumer benefits should not be lightly forfeited on the hope of increased interbrand competition by trademark owners.

Increased interbrand competition alone has not been enough to convince U.S. courts in antitrust cases to sacrifice intrabrand competition.(258) As private agreements to reduce intrabrand competition become more restrictive, less tolerance is displayed by U.S. courts for upholding their validity. Moreover, sufficient interbrand competition must exist before intrabrand restraints are approved.(259) But with an import ban, no review of such market factors is conducted. Instead, an import ban would be a complete restriction on intrabrand competition without any court review for reasonableness of the restriction or sufficiency of interbrand competition. In effect, an import ban would be harsher in its treatment of international diverters than U.S. courts are in the application of antitrust laws in situations involving domestic diverters.

Trademark owners do not need or deserve a perpetual import ban to protect trademark investments from foreign intrabrand competition. Trademark owners maintain that trademarks are actually and legally distinct in each country. From this distinctiveness argument, they assert that they should be protected from imports of intrabrand competitors. Yet, if the marks are factually distinctive in each country, the companies should use distinctive trademarks in each country rather than using the same mark to depict different trademark meanings in each country. No doubt, trademark owners would prefer to save money on the development of new trademarks in each country. However, having the U.S. government create import bans to protect marketing investments of trademark owners is contrary to the principles of “free enterprise” and “free trade.” Trademark owners do not receive protection from intrabrand competition within the U.S. market, and no cogent reason exists for such protection from international markets, especially when the problem has the easy solution (use of a different trademark) within the hands of those who cry for an import ban.

Finally, the import ban is not justified by any special equities on the part of trademark owners. The marketing investments of trademark owners are not entitled to protectionist legislation any more than any other investment by American companies. Whether the situation involves the purchase of a trademark from foreigners (as in Katzel or expenditures for marketing activities, such investments should be subject to the usual market risks. A familiar market risk for trademark investments is the legal doetrine that informs trademark investors that exclusive trademark use extends no further than the “first sale” of the trademarked item.(260) In subsequent sales of the trademarked item, other dealers may use the trademark to indicate that they sell the goods of the trademark owner. This “resale” doctrine is also embodied in the international principle of universality. Once the trademark is attached to the goods and sold, the item can be freely taken across national boundaries for resale. There is no special public interest reason to negate the “resale doctrine” or the universality principle to provide trademark owners with control over subsequent sales of trademarked items.

Recommendations for Legislation

The most appropriate U.S. policy for gray market goods is to eliminate any bans on importation. An import ban is not justified by any special equities for trademark owners, whether it involves a Katzel situation or not. The equities supporting an import ban for U.S. trademark owners are no stronger than the arguments to protect any business investment in America. An import ban is “protectionist” legislation that is inconsistent with U.S. free trade ideology. U.S. policies dealing with domestic diversion of goods and our policies for international diversions should be the same. Since diversions are permitted domestically, they should be allowed internationally as well. Free importation of gray goods would also allow the American consumer to reap the benefits of international intrabrand competition. Lower prices and alternate retail outlets thereby become available to consumers. Also, arbitrage efficiencies are obtained to alleviate currency exchange fluctuations. Therefore, section 526 of the Tariff Act should be repealed. Trademark law also should be legislatively clarified so that it is not used to ban imports or allege infringement against genuine trademarked goods from abroad.(261)

In a market of free importation, free riding and lower prices are expected market risks. Authorized dealers must learn to compete with the unauthorized dealer. But the erosion of trademark goodwill, arising not merely from lower prices, but from consumer deception is not a legitimate market risk. Consumer choice provided by gray market imports is not well served if quality differences in the imports are not disclosed. Therefore, disclosure of product quality and service disparities in gray import goods should be made mandatory.(162)

Gray importers should be required to identify any trademark “Seconds” or products designed primarily for foreign specifications. A label should be conspicuously affixed to disclose quality grade or incompatibility with the U.S. market. Products designed to specifications below U.S. safety or environmental standards should be denied entry without an importer bond to guarantee product adjustments to U.S. standards before retail sale.

Gray retailers also should be required to provide product instructions in English and disclosure of buyer eligibility (or ineligibility) for manufacturer rebate, service, or warranty coverage. Retail advertising of gray dealers should be similarly required to comply with these disclosure policies. Non-complying retailers should be liable both to purchasers returning the product for a refund or credit and to the U.S. trademark owner for unfair competition.

A regulatory system of mandatory disclosure forces gray dealers to differentiate gray goods by labeling and in advertising. It will increase consumer access to information and avoid consumer confusion. It also eliminates some of the unfair aspects of competition of gray imports and provides a limited, but legitimate protection for trademark goodwill. However, the system of regulatory disclosure does not go as far as an import ban, which would protect authorized dealer exclusivity by eliminating import intrabrand competition altogether.

Hence, Congress, in repealing section 526 of the Tariff Act, should also enact tariff laws requiring notice labeling on gray imports to protect consumers. New York, Connecticut, and California have already enacted such provisions for local retailers,(263) but a uniform federal law applying to all gray market imports would be more efficient in the long run.

Adopting a system of mandatory disclosure to protect trademark owners also relieves the courts from struggling with issues of product “genuineness” in order to decide if an import injunction is warranted to protect consumers. Besides avoiding the issues of “genuineness,” the system of mandatory disclosure imposes a more appropriate remedy for consumer confusion

CONCLUSION

Opponents of parallel importation have not been successful in recent times in convincing the White House or Congress that gray market imports in trademarked goods should be banned. Hence, they sued the Customs Service and gray importers as an alternate means to prohibit importation of gray goods. The case against the Customs Service’s interpretation of a 1922 enactment of Congress was sufficient to convince the Supreme Court to overturn the licensing portion of the agency regulations. Proponents of a ban have also begun litigation under the Lanham Act against gray imports of trademarked goods. Such efforts are premised on the same arguments as were presented against section 526 of the Tariff Act and on an expansion of the doctrines of the Katzel decision. Continued litigation is expected–particularly over the notion of “nongenuineness” of the imported goods that, if established, bans importation. Such litigation may cause the perversion of trademark law into a means to ban gray imports and a tool of market allocation in contradiction of long-standing antitrust principles.

Recent litigation, however, has not addressed the underlying issue of whether trademark goods should be banned from importation. The K mart majority did not step beyond statutory construction questions to answer the underlying issue. In addition, lower courts are bound by statutory language and court precedents from directly addressing the underlying issue. Thus, the issue must be answered by Congress, unless Congress is willing to acquiesce in the present policy of an import ban with a “common-control” exception. But then, extensive litigation is to be expected.

Given this country’s commitment to the principles of free trade and that no sufficient reason exists to ban gray imports, it seems more appropriate that Congress should repeal section 526 in its entirety. Congress should also overturn Katzel and clarify trademark law as not applying to genuine trademarked imports. Then, Congress should enact a notice-label law to protect consumers from that portion of gray market imports that are sufficiently different from domestic trademarked goods as to warrant a warning to consumers. Adopting a regulatory system of mandatory disclosure will allow society to capture the benefits of gray market imports while effectively eliminating the dangers of consumer confusion and trademark degradation resulting from quality differences. (1) Gray markets are not generally considered illegal, in contrast to the “black” markets of stolen or counterfeit goods. Rather, “gray” goods are genuine in terms of their manufacturer, but their distribution is “unauthorized” in the sense that the manufacturer or trademark registrant has not authorized the seller to make the sale. See Jamie S. Gorelick & Rory K. Little, The Case for Parallel Importation, 11 N.C.J. Int’l & Com. REG. 205, 207 n.5 (1986)

It shall be unlawful to import into the U.S. any merchandise of foreign
manufacture if such merchandise … bears a trademark owned by a citizen
(or U.S. corporation), and registered in the Patent and Trademark Office by
a person domiciled in the U.S. under the provisions of the … (trademark
laws) and if a copy of the certificate of registration of such trademark is
filed with the Secretary of the Treasury unless written consent of the owner

of such trade-mark is produced at the time of making entry. 19 U.S.C. S 1526(a) (1982). (56) Bourjois & Co. v. Katzel, 260 U.S. 689 (1923). (56) 62 Cong. Rec. 11,602, 11,603 (1922). (57) See Gorelick & Little, supra note 1, at 214-216, (asserting Congress intended to limit the scope of Section 526 to the specific inequity of Katzel). (58) See Steven P. Kersner & Donald S. Stein, Judicial Construction of Section 526 and the Importation of Grey Market Goods: From Total Exclusion to Unimpeded Entry, 11 N.C.J. Int’l L. & Com. Reg. 251-291 (1986). Kersner and Stein assert that the legislative history of 526 is “confusing” and fails to rise to the level of “clearly expressed legislative intention contrary to the express language of the statute” as required by the Supreme Court before such plain statutory language may be disregarded. Id. at 259. (59) Kersner & Stein, supra note 57, at 254

(b) Identical trademark. Foreign-made articles bearing a trademark identical
with one owned and recorded by a citizen of the United States or a
corporation or association created or organized within the United States are
subject to seizure and forfeiture as prohibited importations.
(c) Restrictions not applicable. The restrictions set forth in paragraphs a and
b of this section do not apply to imported articles when:
(1) Both the foreign and the U.S. trademark or trade name are owned by
the same person or business entity
(2) The foreign and domestic trademark or trade name owners are parent
and subsidiary companies or are otherwise subject to common ownership or
control (see [sections]133.2(d) and 133.12 (d)).
(3) The articles of foreign manufacture bear a recorded trademark or trade
name applied under authorization of the U.S owner. (Section 133.21(c) was amended by removing paragraph (c)(3) and marking it “reserved.” 55 Fed. Reg. 52,041 (1990).) (61) In the application to record a registered trademark with the Customs Service, the U.S. trademark owner must disclose:
The identity of any parent or subsidiary company or other foreign company
under common ownership or control which uses the trademark abroad. For
this purpose:
(1) “Common ownership” means individual or aggregate ownership of more
than 50 percent of the business entity
(2) “Common control” means effective control in policy and operations and

is not necessarily synonymous with common ownership. 19 C.F.R. [sections]133.2(d)(1985). (62) T.D. 40,380, 46 Treas. Dec. Int. Rev. 165 (1923). (63) T.D. 48,537, 70 Treas. Dec. Int. Rev. 336 (1936). (64) T.D. 53,399, 88 Treas. Dec. Int. Rev. 376 (1953). (65) Kersner & Stein, supra note 57, at 263. (66) Section 2 prohibits monopolizing or attempting to monopolize trade. Sherman Act [sections] 2, 15 U.S.C. [sections] 2 (1982). (67) 155 F. Supp. 77 (S.D.N.Y. 1957), vacated and remanded, Guerlain, Inc. v. U.S., 358 U.S. 915 (1958), dismissed, 172 F. Supp. 107 (S.D.N.Y. 1959). (68) Id. (69) Motion to vacate judgments and to remand to the District Court for consideration of motion to dismiss filed by the United States. Guerlain, Inc. v. United States, 358 U.S. 915 (1958). (70) Motion to Vacate at 7, Guerlain, Inc. v. United States, 358 U.S. 915 (1958). (71) Id. (72) Id. at 7-8. H.R. 7234 was the resulting bill. See Robert A. Bicks, Antitrust and Trade-Mark Protection Concepts in the Import Field, 49 Trademark Rep. 1255, 1260 (1959). (73) T.D. 54,932, 94 Treas. Dec. Int. Rev. 433 (1959). (74) See supra notes 60 and 61. (75) Service arguments have been presented in Olympus Corp. v. United States, 792 F.2d 315, 319 (2d Cir. 1986), cert. denied, 486 U.S. 1042 (1988)

Any person dealing in any such merchandise may be enjoined from dealing
therein within the United States or may be required to export or destroy
such merchandise or to remove or obliterate such trade-mark and shall be
liable for the same damages and profits provided for wrongful use of a

trademark …. (100) Vivitar Corp. v. United States, 761 F.2d 1571 (Fed. Cir. 1985), cert. denied, 474 U.S. 1055 (1986). (101) Olympus Corp. v. United States, 792 F.2d 315 (2d Cir. 1986), cert. denied, 486 U.S. 1042 (1988). (102) Olympus Corp., 792 F.2d at 320. In July 1989, the District Court for the Southern District of New York, citing Olympus, wrote, “It is the unchanged law of this Circuit that the U.S. trademark owner … retains its private remedies against the importer under … (section) 526(c) of the Tariff Act of 1930.” Duracell Inc. v. Global Imports, Inc., 12 U.S.P.Q. 2d (BNA) 1651 (1989). (103) See, e.g., Duracell Inc., v. Global Imports, Inc., 12 U.S.P.Q.2d (BNA) 1651 (1989)

The redress that is accorded trademark cases is based upon the party’s right
to be protected in the goodwill of a trade or business…. Where a party
has been in the habit of labeling his goods with a distinctive mark, so that
the purchasers recognize goods thus marked as being of his production,
others are debarred from applying the same mark to goods of the same
description, because to do so would in effect represent their goods to be of
his production and would tend to deprive him of the profit he might make
through the sale of the goods which the purchaser intended to buy. Courts
afford redress or relief upon the ground that a party has a valuable interest
in the good-will of his trade or business, and in the trademarks adopted to
maintain or extend it. Hanover Star Milling Co. v. Metcalf, 240 U.S. 403, 412 (1916).

The protection of the trademark symbol and the mark owner’s goodwill from expropriation by others was also recognized by Justice Frankfurter in a 1942 decision:
The protection of the trade-name is the law’s recognition of the psychological
function of symbols. If it is true that we live by symbols, it is no less true
that we purchase goods by them. A trademark is a merchandising short-cut
which induces a purchaser to select what be wants, or what he has been led
to believe he wants. The owner of a mark exploits this human propensity
by making every effort to impregnate the atmosphere of the market with
the drawing power of a congenial symbol. Whatever the means employed
the aim is the same — to convey through the a mark, in the minds of potential
customers, the desirability of the commodity upon which it appears. Once
this is attained, the trademark owner has something of value. If another
poaches upon the commercial magnetism of the symbol he has created, the

owner can obtain legal redress. Mishawaka Rubber and Wollen Mfg., Co. v S.S. Kresge Co., 316 U.S. 203, 250 (1942). (113) S. Rep. No. 1333, 79th Cong., 2d Sess. 3, reprinted in 1946 U.S. Code Cong. and Admin. News 1274. (114) Miller & Davis, supra note 109, at 179-83. (115) Id. at 180-81. (116) See Yale Elec. Corp. v. Robertson, 26 F.2d 972 (2d Cir. 1928)

(1) Any person who shall, without the consent of the registrant use in
commerce any counterfeit, copy, or colorable imitation of a registered mark
in connection with … any goods (so that) … such use is likely to cause
confusion, or to cause mistake, or to deceive … shall be liable in civil action
by the registrant…. (121) See Osawa & Co. v. Bell & Howell Photo, 589 F. Supp. 1163, 1171-72 (S.D.N.Y. 1984)

JAMES E. INMAN, Professor of Business Law, College of Business Administration, University of Akron.