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Costco Wholesale Corp. v. Omega S.A.: The Beginning of Gray Market Confusion and the End of First Sale Doctrine Protection for Retailers and Consumers

Published onAug 31, 2011
Costco Wholesale Corp. v. Omega S.A.: The Beginning of Gray Market Confusion and the End of First Sale Doctrine Protection for Retailers and Consumers

On December 13, 2010, the Supreme Court issued its decision in its de novo review of the Copyright Act’s impact on foreign-made goods and the first sale doctrine in Costco Wholesale Corp. v. Omega S.A. [hereinafter Costco v. Omega]. With Elena Kagan recusing herself, the Court’s 4-4 decision preserved the Ninth Circuit’s decision in favor of Omega.  Due to the rare split, no precedential value attached to the Court’s ruling, leaving in place the rejection of the first sale doctrine within the Ninth Circuit for foreign manufactured goods without affecting the interpretations of the doctrine in other circuits.  So, if you find yourself in California in the near future, you may want to hold off on purchasing that discounted digital camera from a price-savings club.  What appears to be an innocuous purchase may well be in contravention of the Ninth Circuit’s interpretation of the so-called “gray market:” if the camera has been manufactured in a foreign jurisdiction, it may potentially violate copyright infringement statutes designed to prevent the alienability of goods in secondary markets.

“Gray-market” goods are authentic products under a brand name protected by a trademark or copyright.  Typically, these products are manufactured abroad, then purchased and imported into the United States by third parties, bypassing authorized U.S. distribution channels.  As a result, retailers are able to offer gray-market goods to consumers at a discount due to the international discrepancies in the manufacturers’ pricing systems.

Although issues such as the one presented in Costco v. Omega don’t garner the same attention as their more passion-inspiring counterparts, these cases — which include shareholder suits, antitrust challenges to corporate mergers, patent disputes and efforts to reduce punitive-damage awards and prevent product-liability suits — are no less important.  They involve billions of dollars, have huge consequences for the economy and can have a greater effect on people’s daily lives than the often symbolic battles of the culture wars.

As the issue stands now, the Supreme Court’s December non-decision “affirms [within the Ninth Circuit] a windfall for copyright owners—never-ending control of foreign-made works until a U.S. sale is made with the copyright owner’s consent.”  James L. Bikoff, et. al, Costco v. Omega: The ‘Foreign First Sale’ Debate, Westlaw J. Intellectual Prop. (2011).  American employees and businesses will suffer as the manufacture of goods intended for foreign sale are moved abroad in order to afford copyright owners maximum protection under current law, causing injury to an already struggling manufacturing economy.  Id.  Consumers will suffer as well from the disparities in pricing that are ultimately at the root of this issue—forced to pay significantly higher prices for copyrighted goods that may have no difference in value compared to their foreign-market counterparts. Id.  Carried to the extreme, the Supreme Court’s failure to overrule the Ninth Circuit, and its likely upholding of a narrow first sale doctrine interpretation in future decisions, will mean that “reselling practically anything made abroad—a Japanese made Toyota, not to mention all the things ‘made in China’—becomes copyright infringement.

The crux of the controversy in both Costco v. Omega and the seminal first-sale doctrine case, Quality King v. L’anza Researcherslies in the interpretation of § 109(a)’s phrase “lawfully made under this title.”  The first sale doctrine has been long recognized by American courts as a defense to copyright infringement.  Over a century ago, the Supreme Court held, “one who has sold a copyrighted article, without restriction, has parted with all right to control the sale of it.” The first sale doctrine seeks to strike a “balance between the property rights of consumers and the promotion of progress in the sciences and useful arts that results from compensating copyright owners for the initial sale” of copyrighted goods, protecting the alienability of such goods and enabling them to be resold or redistributed unhindered by the copyright owner’s control.  Without realizing the implications, this doctrine is what enables citizens to exert control over many products: borrow books from libraries, present a compact disc as a gift, or put that duplicate pair of shoes up for auction on eBay.

In reaching its decision in Costco v. Omega, however, the Ninth Circuit held that Quality King was distinguishable because that case involved goods manufactured in the United States, initially sold abroad, and imported back into the United States—so-called “round-trip” goods.  The Ninth Circuit’s Omega decision concluded that, as a matter of law, foreign sales of foreign-made goods do not exhaust a copyright owner’s right to distribution under § 106(3), accepting the construction of the doctrine advanced by Omega: § 109(a)  “grant[s] first sale protection only to copies legally made and sold in the United States.” In doing so, the Ninth Circuit “imposed a place of manufacturing requirement on the first sale doctrine for goods manufactured abroad by United States copyright owners and imported and sold in the United States.”  The effect of this decision places severe restraint on the consumer’s potential for alienation, in contravention of the policy against such restraints.  The decision gives manufacturers an increased ability to dictate the downstream sales of goods for which they have been previously compensated. Indeed, the Ninth Circuit’s decision seems incongruous with long-held tenets of American consumer culture: “once a consumer pays the copyright owner for a good in an authorized first sale, the purchaser should enjoy the right to freely distribute that good, irrespective of where the good was manufactured.”

Costco’s proponents went on the offensive, taking the opportunity to criticize what they termed as the Ninth Circuit’s “gutt[ing]” of the traditional interpretation of the first stale doctrine and the overturning of the Quality King decision.  Julia Reischel, Copyright Case Submitted the U.S. Supreme Court Could Have Big Impact on Foreign Trade, Mass. Law. Wkly. 2009 WLNR 23220583, Nov. 16, 2009.  A number of court cases point to the “full-scale battle” that has been launched by manufacturers to seek regulations granting control over the downstream flow of foreign market goods into the United States.  “Historically, manufacturers have typically attempted to prevent the importation and sale of gray market products through trademark law.”  After adverse results in other areas of law, “manufacturers are now realizing that copyright may furnish a supplemental vehicle for protection.”  2 Nimmer on Copyright § 8.11[B][4] (2009).  Corporations see profit potential in the attempt to “use copyright law to hamper the ability of consumers’ and resellers’ to redistribute goods from comparison-shop from different vendors.”

The magnitude of allowing the Ninth Circuit’s decision to stand is incomprehensible to many until one takes a look at the raw numbers: by placing foreign-manufactured goods outside the scope of the first sale doctrine, secondary markets with annual revenues in the $40 to $60 billion dollar range would be eliminated, along with the tax revenues that are generated by those sales.  Similarly, the estimated $200 billion market for used goods would also be eliminated; “[a] copyright holder could choose to stay silent upon the first sale of a good made abroad but then bring an action for infringement if it disagreed with terms of the good’s resale.”  With “no means to determine where the goods were manufactured, whether and where a prior sale occurred and whether the copyright owner had authorized the prior sale,” commerce in the secondary market would be “unsustainably burden[ed],” ultimately translating into higher costs for consumers.

Manufacturers that seek to control the retail pricing structure of their goods do not seem to recognize that a substantial portion of their client base may not be able or willing to purchase their goods at the higher rate.  Indeed, in the modern retail culture of savings clubs, Craigslist, price-match guarantees,, and Amazon’s familiar price strikeout and “You Save” percentage, many consumers are ingrained with the notion that prices are never firm and a better deal may be had elsewhere.  As the practice of importing gray market goods became more prominent during the 1980s in response to variations on the strength of the dollar, consumers arguably became less willing to pay, or even aware of, full retail price.

In addition to the threat posed to the traditional market constructs of retailer and consumer, “by producing goods abroad, copyright holders would suddenly gain the right to restring rental-, lease- and other lending-based markets.” § 106(3) grants the copyright owner the exclusive right “to distribute copies or phonorecords of the copyrighted work to the public by … lending.” For example, in restricting the application of § 109(a) to copies manufactured domestically, the Ninth Circuit’s decision “threatens the ability of libraries to continue to lend materials in their collections,” including the some 200 million books in American libraries by foreign publishers.  In addition to the threat of potential copyright infringement liability, libraries will face mounting acquisition costs that would prevent institutions from continuing to add new materials to their collections if they want to continue to provide the service that boasts 2.2 billion circulation transactions per year.  If a library did wish to acquire a copy of a work that was not clearly manufactured in the United States, the library could be forced to obtain a “lending license” at a substantial premium.  Omega’s impact on the overall educational, vocational, and cultural atmosphere of the United States may be far-reaching, and not understatedly, devastating.

Finally, and perhaps most pointedly, the impact on American manufacturing cannot be underestimated.

[B]y granting greater protections against competition to goods made abroad than to those made at home, the Ninth Circuit’s opinion creates perverse incentives for U.S. copyright owners to produce their copyrighted works outside the United States, thereby eliminating American jobs.

In repealing § 109(a)’s manufacturing requirement, “Congress was sensitive to creating incentives for overseas manufacturing and creating a trade imbalance,” concluding that “although there may have been some economic justification [for the manufacturing requirement] at some time, that justification no longer exists.”  The imposition of a place of manufacturing requirement on § 109(a) could lead to significant domestic economic depression “[a]s increased transaction costs may curtail trade, [and] importers and resellers … face a diminishing market and concomitant job loss.”  Additionally, already-staggering trade deficits would undoubtedly increase.

The implications of the Costco v. Omega decision are profound.  In order to protect and promote American manufacturing and business, it is necessary that the threats posed by narrowly construing § 109(a) to exclude foreign-made goods be taken seriously by both courts and legislatures in considering where to go forth following the Supreme Court’s ruling in Costco v. Omega.

* Greer Benge is a third-year law student at Wake Forest University School of Law and is Symposium Editor for the Wake Forest Journal of Business and Intellectual Property Law.  Ms. Benge holds a Bachelor of Arts in Political Science and Art History from the University of North Carolina at Chapel Hill.  Upon graduation in May 2012, Ms. Benge intends to practice trademark and copyright law and hopes to continue buying gray market merchandise on eBay.

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