Gray market goods are products with legitimate copyright or trademarks that are authorized for sale in one country, but then imported without authorization in another country. Companies that sell gray market goods work outside the normal distribution channels by purchasing the goods at a cheaper price in one country, importing them to an unauthorized country, and then selling the product in that unauthorized country at a profit, but at a lower price than what is offered through the authorized distribution channels.

Companies need to be able to control their intellectual property; however, these gray market goods impede a company’s ability to adequately protect its good will. One aspect of gray market goods is that a product intended for a certain demographic ends up in another, which can cause customers to lose trust that a product will have the desired and expected quality, features or attributes in different markets to meet local consumer tastes, demands and competitive marketplace.

For example, consumer electronic and food products vary significantly in different parts of the world. If a consumer in one country buys a product intended for a different market, they may not receive the product they expected. A company also may tailor its product advertising and packaging for a particular market (colors, designs, music, etc.). Some companies enter distribution contracts with authorized dealers, but the relationship is disrupted by unauthorized products in the territory. The company has no power to regulate the price or quality of these unauthorized goods and the distributor loses sales revenue on products purchased by consumers from unauthorized sellers.

U.S. trademark and copyright laws provide remedies (via via U.S. Customs or judicial proceedings) to the intellectual property owner to address these gray market goods, although these laws can be somewhat limiting. Trademark owners can only prevent importation of goods that are physically and materially different than the authorized U.S. goods. This means that if the imported product is identical to the authorized product, the trademark owner cannot prevent importation and sale. Also, the importers can get around this rule by adding disclaimers on product packaging to cure customs regulations violations.

For copyright owners, a new trend has been asserting copyright violations under international treaties and conventions; however, this has not been a viable strategy in most cases. Under the copyright misuse doctrine, copyright cannot be asserted to secure exclusive rights not granted by the U.S. Copyright Office. This means that you cannot try to extend your rights granted by the copyright beyond what was allowed in the grant. Copyright owners are finding that the misuse doctrine is limiting their ability to prevent the importation of gray market goods. The argument is that copyright is to protect creative expression, not to prevent importation of gray market goods. Attempting to do so would subject the copyright owner to the misuse doctrine because such assertion of rights expands beyond those created under copyright law. The defensive shield of copyright law cannot be used as an offensive sword.

Interestingly, the Ninth Federal Circuit (covering California) has expanded the use of the copyright misuse doctrine in a battle between Costco and Omega over Omega watches. Omega is a Swiss company that manufactures luxury watches and other jewelry. In 2004, Omega initiated a legal battle against Costco over Omega’s “Seamaster” watches, which were authorized for sale in Europe, but not in the US, where it uses a network of distributors. Omega’s watches have a suggested retail price of $1,995. Costco was selling their gray market version for $1,299. This version had a small globe design on the back of the watch – a copyrighted design registered to Omega. Costco is alleging that its purchases are valid under the first sale doctrine, which would allow resale in the US after the watches were first sold to foreign distributors. Costco is further alleging that Omega is attempting to extend its limited copyright outside of what is permitted by the copyright grant (copyright misuse).

The Ninth Circuit will be deciding an appeal to determine if the federal district court’s preclusion of the application of the copyright misuse doctrine to prevent gray market goods should be upheld. If it is upheld, the implications could be far reaching, perhaps eliminating an entire protection strategy for global companies. The Second Circuit that covers New York may, but would not be required to, adopt the same reasoning and juries prudence as the Ninth Circuit. The legal community will monitor with great attention how the Ninth Circuit (and subsequently the Second Circuit) deals with these issues and whether copyright law will no longer provide a viable approach to gray market goods.