Articles Posted in Business Law

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Product diversion is when an unauthorized seller sells a product outside of authorized distribution channels. The product goes through various unauthorized channels in order to reach the shelves or listings on a website. This is a common practice with high end and expensive beauty products.

The way these unauthorized retailers and e-commerce sites obtain these products often involves reaching out to an authorized seller of the product. For example, many manufacturers have a contract with various salons to exclusively sell their products. These salons, in turn, sell the products per their contract. However, there are salons that work in the gray market. The ones that are in the gray market enter into deals with a third party that offers to buy the items in bulk. The third party then sells the item to an unauthorized seller. The unauthorized seller then sells the items on websites such as eBay and Amazon.

The danger of diverted products going through these unauthorized channels are high for both the consumer and business. For example, products can be tampered with during the process. Products can change bottles, be diluted, and more. It could cause health problems for those who are sensitive towards certain ingredients. It can also be dangerous to businesses because it will hurt their profits. The businesses will lose their cut of product sales from the authorized seller and can receive negative reviews from the public. For example, if a consumer, who has used Brand X body wash for years, buys the Brand X body wash from an unauthorized reseller because it was cheaper on Amazon than in store and has a severe allergic reaction to it, then he/she may be tempted to post a negative review. The problem is that the blame is not on Brand X, but on whoever tampered with the product before it was sent to the consumer. Although, the blame is on someone else, Brand X will receive the negative review that will discourage other consumers from purchasing its product.

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In recent times, counterfeit items have become a large problem for many designer luxury brands. With the rapid growth of e-commerce, counterfeiters have moved their products from the streets to the Internet. This creates a problem for designer luxury brands because it is not easy for counterfeit items to be sold before their eyes. The sale of counterfeit items can affect everything from sales, to reputation, to good will. Many designer luxury brands are players in the fashion industry. The fashion industry, however, is a fickle one. One day you are in, the next you are out. The biggest asset a designer luxury brand can have is its status. Once the brand starts to lose its status in the industry, it is difficult to recover.

Protection of intellectual properties against unfair competition has become a constant battle for designer brands. The latest battle comes between French luxury company, Kering, and Chinese e-commerce giant, Alibaba. Kering luxury brands include, Gucci, Yves Saint Laurent, and more. In May 2015, Kering filed a lawsuit against Alibaba for encouraging and profiting from sales of counterfeit items on its website. This lawsuit, however, is the second legal action between the two parties. The first lawsuit was filed in July 2014 with similar causes of action. The lawsuit was retracted when Alibaba promised to work towards stricter intellectual property protections. However, Kering became frustrated with the lack of progress and filed the second lawsuit in 2015.

In its complaint, Kering alleges that Alibaba encourages counterfeiting on its platforms by allowing keywords such as “replica” and “guchi” to lead to counterfeit items. The complaint alleges Alibaba fosters the sales and purchase of counterfeit goods by providing a platform for such transactions. Alibaba, however, argues the lawsuit is frivolous and claims that it works with luxury brands to help protect their intellectual property.

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In general, trademarks are marks that are associated with a particular brand. Examples of trademarks include the golden arches for McDonald’s and the mermaid for Starbucks. Trademarks are important to businesses because they distinguish the business from its competitors. Businesses use these marks in marketing to gain consumer attention. Once a consumer is familiar with a brand, has developed a positive opinion on it, then he or she is more likely to buy products from the brand.

However, when a particular business becomes successful, competitors will often try to emulate the business’s model and possibly engage in deceptive practices. A common practice is trademark infringement. Trademark infringement is when a business takes another business’s trademark and creates a similar mark. What the infringing business is banking on is consumer confusion. It is hoping that consumers will be under the impression that the infringing business is associated, or possibly, even be the business that actually holds the mark. The infringing business is then taking away sales from the authorized trademark holder.

Dangers of Online Trademark Infringement

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If you have ever been involved in a federal civil lawsuit, you may be familiar with the Federal Rules of Civil Procedure (FRCP).  The FRCP are a set of rules that regulate federal civil lawsuits. The rules address issues from court and party obligations to enforcement of remedies. The FRCP was first adopted by order of the Supreme Court in 1937 and placed into effect in 1938.

On December 1, 2015, these rules were amended. Many of the changes affect electronic discovery (e-discovery). Prior to the internet age, discovery and discoverable evidence were primarily based upon paper transactions.  With the rapid rise of the web, many started to turn to electronic storage of information.  As the data and information-storage landscapes began to change, the rules had to change.

The amendments brought changes to Rules 1, 4, 16, 26, 30, 31, 33, 34, 37, and 55.  The amendments also brought on the abrogation of Rule 85 and the Appendix of Forms. The changes that affect e-discovery are as follows:

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The internet has become the home to many advances in the world. With one click of a button, a person can communicate with another person located on the other side of the world. With another click of a button, a person can buy a shirt and have it delivered right to his/her doorstep in a matter of days. Not only has the internet made things more convenient, it has become a tool in starting a business. Besides finding a tutorial to create a website, inventors can now fund their projects to bring their ideas to reality through crowdfunding. The inventor simply places his idea on a crowdfunding website, e.g., Kickstarter or Indiegogo, and sends the link to a large group. Depending on the invention’s popularity, the entrepreneur can raise a high amount of money with little effort.

Crowdfunding is starting to become a viable source of funding for startups. According to Forbes, crowdfunding is predicted to overcome venture capitalists next year.  Although, crowdfunding has made it easier to create a business, it does not come without legal problems. One of the biggest issues is intellectual property. From patent trolls, to patent infringement, crowdfunding websites have found themselves under attack by businesses.

In late 2012, 3D Systems brought a patent infringement lawsuit against Formlabs.  3D Systems alleged both direct and indirect patent infringement for its three-dimensional printing technology. This lawsuit came after Formlabs collected over $2 million from its crowdfunding campaign to put its three-dimensional printer into production. Formlabs was planning on selling the printer for less than 3D Systems’ printer, leading to the filing of the complaint. No answer was ever filed in the original suit, but a series of time extensions indicated that the companies were looking for a settlement. In late 2013, a notice of voluntary dismissal was filed and a settlement looked imminent.

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ZeniMax Media, Inc. (“ZeniMax”) is a company that develops and publishes video games. These games include Fallout and Elder Scrolls. ZeniMax publishes the video games through its subsidiaries and has found widespread success in the gaming market. With that widespread success, ZeniMax was able to allocate funds for the development of virtual reality gaming.

In April 2012, a ZeniMax employee started communicating with Palmer Luckey. At the time, Luckey was a college student working on a virtual reality headset prototype named Rift. The ZeniMax employee took interest in Luckey’s creation and offered some help in its development. Luckey then sent the ZeniMax employee a copy of his prototype where the employee and other ZeniMax personnel added their own improvements. After their improvements, ZeniMax entered into a Non-Disclosure Agreement with Luckey to share the enhancements made on the prototype, including its use in a game ZeniMax developed.

After the prototype became a working model, ZeniMax performed demonstrations at the Electronic Entertainment Exposition. The demonstrations were only done by appointment. After adding his own modifications and merely days after the exposition, Luckey started to commercialize the headset under a newly-formed company called Oculus VR.

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On October 30, 2015, the Securities and Exchange Commission (“SEC”) adopted rules allowing the use of crowdfunding by companies to offer and sell securities. Crowdfunding is the raising of money in cyberspace through portals, i.e., specialized websites like Gofundme, Indiegogo, Kickstarter. By using these portals, individuals or businesses can engage in fundraising in order to promote ideas to a large group of potential investors.  Crowdfunding has become a handy tool in new projects since it is another method for a small business to raise capital.  The SEC is seeking to regulate these practices and to protect investors since startups and entrepreneurs can raise capital through this revolutionary method.

For example, Title III of the Jumpstart Our Business Startups (“JOBS”) Act created an exemption in the securities laws to allow crowdfunding to be used for offering and selling securities. The exemption called for the final rules, Regulation Crowdfunding, to administer such offerings and sales. The rules allow for crowdfunding securities transactions within certain limits. The limits include the amount that could be raised through crowdfunding, requirement of disclosure of certain information to investors, and creation of a regulatory framework for the funding portals, which facilitate the transactions.

In essence, some of the rules are:

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Trade secrets are vital to a business’s growth and development.  From a practical standpoint, the advantage a business may have vanishes once the trade secret is publicly known. As a result, businesses have employed various methods to prevent the leaking of trade secrets. From confidentiality agreements to encryption, a smart business should attempt to prevent the risks. However, these efforts may not be enough, calling for the need of regulation. In general, the applicable regulations primarily clarify the definitions, parameters, and remedies for trade secret theft.

Uniform Trade Secrets Act

The Uniform Trade Secrets Act (UTSA) has been adopted in forty-seven states and the District of Columbia. It defines a trade secret as information that derives economic value from its secrecy and is subject to reasonable effort to maintain its secrecy.

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What are trade secrets?

In general, the definition of a trade secret varies from state to state. Essentially, it means any confidential information you would not want your competitors to know about. This could be anything from customer lists, marketing plans, to business models. Although, this definition is broad, it is important to look at the exact definition of what is a trade secret according to the applicable jurisdiction. In California, a trade secret is defined as information that takes independent economic value from its confidential nature subject to reasonable efforts to maintain its secrecy. Here, California’s definition of a trade secret places a focus on economic impact. This differs from states such as New York where the law simply defines a trade secret as information that would give an advantage over a competitor. See Ashland Mgt. v. Janien, 82 N.Y.2d 395, 407 (1993). In comparison, New York has a broader definition than California and covers any non-economic related trade secrets.

Why is protection necessary?

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On August 24, 2015, the United States Court of Appeals for the Third Circuit handed down its decision in favor of the Federal Trade Commission (FTC) against Wyndham Worldwide Corporation.  This lawsuit was against the defendant and its subsidiaries for their failure to implement proper cybersecurity measures and protect consumers’ personal information against hackers.  The FTC alleged that defendants did not use encryption, firewalls, and other commercially reasonable methods for protecting personal information.

What was the basis of the lawsuit?

In general, the FTC has the responsibility to protect consumers against unfair and deceptive business practices. These illegal practices could range from false advertising to antitrust issues. The FTC has started to prosecute companies with inadequate cybersecurity to protect consumer data. The companies that made false statements about their level of security in their terms of service also had lawsuits filed against them.  In this case, between 2008 and 2009, hackers breached Wyndham Worldwide Corporation’s network and computer systems three separate times. One incident occurred in 2008 and two occurred in 2009.   The hackers were allegedly able to breach the network due to the use of weak and obvious passwords, lack of response to the first incident, and inadequate monitoring systems.  In one of the instances, it took approximately two months for Wyndham Worldwide Corporation to discover its systems had been accessed without authorization. The hackers successfully accessed personal information of approximately 619,000 consumers and managed to cause $10.6 million in fraudulent charges. Therefore, on June 26, 2012, the FTC brought the lawsuit against defendants.  Their motion to dismiss was denied by the district court and their appeal was heard on two issues in order to determine whether there was a valid claim.  The issues that were raised included: (1) whether the FTC had authority to regulate cybersecurity under 15 U.S.C. § 45; and (2) if so, whether defendants received fair notice that their cybersecurity practices were inadequate under the guidelines.

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