Costco Allowed to Protect Its Suppliers' Identities as Trade Secrets In a Manufacturer's "Unauthorized Retailer" Action

Case: Citizens of Humanity, LLC v. Costco Wholesale Corp., Cal. Court of Appeal, Second District No. B204117 (2/11/09)

The One Sentence Summary: In a manufacturer's suit challenging Costco's sale of high end jeans intended for sale only at authorized retailers, Costco was allowed to keep secret the names of its suppliers as a trade secret.


What They Were Fighting About: Citzens, a manufacturer of high fashion jeans sold only in exclusive retailers, learned that some of its jeans were being sold at Costco. After buying the jeans at Costco, Citizens learned from tags on the jeans that the Costco jeans must have come from three to five of Citizens' authorized retailer customers. Citizens surmised that the jeans must have been stolen, and sued Costco for selling stolen goods.

Citizens sought discovery from Costco identifying the suppliers of the jeans to Costco. Costco refused to identify its suppliers, claiming that the identity of its suppliers was a valuable trade secret. The trial court ordered Costco to provide discovery about the transactions where it obtained the jeans, but granted a protective order allowing Costco to remove the names of its suppliers from the production.

After discovery, Citizens amended its complaint to allege sale of stolen goods, conspiracy to commit fraud, and unfair competition. The trial court sustained a demurrer to the amended complaint, and Citizens appealed.

Second District Court of Appeal Holdings:

• The court began by characterizing this case as a form of "unacceptable retailer" claim where a manufacturer attempts to prevent discount retailers or other types of outlets from selling the manufacturer's products. Noting that California courts had not ruled upon "unacceptable retailer" cases, the court surveyed cases from other states, identifying the "hurdles" that a manufacturer faces:

  As a general rule, our society favors competition. Once the manufacturer has sold its goods to a distributor, the manufacturer can have no control over the retailers to whom the distributor resells the goods. If the manufacturer wishes to retain this control, it can best do so by means of its contract with its distributors. Even then, the manufacturer’s remedy is generally against its distributor for breach of contract; the manufacturer can only pursue the retailer if the retailer maliciously induced the breach.

  (Slip Opinion at 12). The court observed that plaintiff Citizens attempted to bypass these rules by avoiding tort claims for interference with contract or trademark. Rather, Citizens claimed that Costco knowingly sold stolen goods or conspired to commit fraud to obtain the jeans through misrepresentations.
• The court next affirmed the trial court's ruling that allowed Costco to keep secret the identities of its suppliers of Citizens' clothing. Costco had shown that the identity of its suppliers was a trade secret, i.e., valuable information not known to Costco's competitors that Costco took reasonable measures to protect.
• Citizens did not establish that it needed disclosure of the trade secret identities of Costco's suppliers in order to prove its claim that the jeans were stolen. Citizens did not need information from Costco because tags on the jeans identified only a small number of authorized retailers to which Citizens supplied the jeans, and Citizens could inquire of those retailers whether a theft had occurred.
• The appellate court ruled that the trial court should not have sustained the demurrer dismissing plaintiff's claim alleging knowing sale of stolen goods.
  
• The court rejected Costco's causation argument that Citizen's injury was not related to the alleged theft of the jeans, but rather to Costco's sale at a warehouse store rather than at a high end retailer. In rejecting this argument, the court noted that the purpose of section 496(c) of the Penal Code was to allow anyone harmed by the sale of stolen goods to bring a civil action.
• The court rejected Costco's argument that harm to Citizens' goodwill from the discount sale of its jeans could not be "actual damages" under section 496(c) of the Penal Code.
• The court affirmed dismissal of Citizens' fraud claim because Citizens failed to allege with particularity who made what misrepresentations or failures to disclose, and whether those misrepresentations were express or implied. Citizens had control of the information necessary to allege fraud because it knew which of its authorized retailers had received Citizens' jeans, and Citizens therefore knew what representations were made as to resale of the jeans.
• The court affirmed dismissal of Citizens' statutory unfair competition claim under section 17200 of California's Business and Professions Code because Citizens lacked standing. The court held that standing to bring a suit under section 17200 is limited to those who have lost money or property that could be restored by an order of restitution. Because harm to goodwill cannot be the basis of restitution, Citizens did not have standing under section 17200.
  
  

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Statutory Implied Warranty Under California UCC of No "Rightful" Claims Is Breached by Nonfrivolous Trademark Infringement Claims

Case: Pacific Sunwear of California, Inc. v. Olaes Enterprises, Inc., No. D051391 Fourth Dist., Div. One. (Oct. 9, 2008)

The One Sentence Summary: Unsuccessful trademark infringement claims asserted against the buyer of "Smile Now, Cry Later" Hot Sauce Monkey shirts supported the buyer's claim that the seller breached the statutory implied warranty of section 2312(3) of the California Uniform Commercial Code to provide goods that were free of "rightful claims."




What They Were Fighting About: Oales sold Hot Sauce Monkey t-shirts to Pacific Sunwear. These shirts depict on the front, a monkey drinking a bottle of hot sauce and, on the back, the same monkey in apparent pain, expelling fire. Centered underneath each of the images is a two-word caption: on the front, the phrase "Smile Now"; on the back, the phrase "Cry Later." SNCL, the holder of a registered trademark for Smile Now, Cry Later, made trademark infringement claims against Pacific Sunwear. In the trademark litigation in Hawaii, the court denied a motion for preliminary injunction, finding there was no likelihood of confusion after which the case settled.

Pacific Sunwear then sued Olaes for breaching the statutory warranty that the Hot Sauce Monkey T-shirts were "free of the rightful claim of any third person by way of infringement or the like." (§ 2312(3).)

The trial court granted summary judgment for Olaes, holding that the underlying claims of infringement were not "rightful claims" in light of the federal court's ruling that there was no likelihood of confusion.

California Uniform Commercial Code section 2312 states as follows:

"(1) Subject to subdivision (2) there is in a contract for sale a warranty by the seller that

"(a) The title conveyed shall be good, and its transfer rightful; and

"(b) The goods shall be delivered free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge.

"(2) A warranty under subdivision (1) will be excluded or modified only by specific language or by circumstances which give the buyer reason to know that the person selling does not claim title in himself or that he is purporting to sell only such right or title as he or a third person may have.

"(3) Unless otherwise agreed a seller who is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like but a buyer who furnishes specifications to the seller must hold the seller harmless against any such claim which arises out of compliance with the specifications."

California Court of Appeal Holdings:

• The phrase "free of the rightful claim of any third person by way of infringement or the like" in California Uniform Commercial Code section 2312 should be interpreted by reference to the commentary to section 2-312 of the Uniform Commercial Code in the absence of other evidence of legislative intent as to the meaning of "rightful claim."
• The commentary to the Uniform Commercial Code makes it clear that the term "rightful claim" as used in the statute is intended to broadly encompass any nonfrivolous claim of infringement that significantly interferes with the buyer's use of a purchased good.
• Other states have interpreted their statutes enacting section 2-312 of the Uniform Commercial Code consistently with the commentary that a rightful claim need not be a meritorious claim.
• Public policy reasons also support interpreting section 2312 to extend to nonfrivolous claims. A merchant regularly dealing in goods of the kind has superior knowledge of potential claims and more incentive to resolve them than a buyer. Additionally, the parties can expressly contract to alter the implied warranty under section 2312.
• The existence of a reverse warranty from buyer to seller in the case of buyer-supplied specifications under section 2312(3) supports the interpretation of section 2312.
• Interpreting section 2312 to extend to nonfrivolous claims provides a clear allocation of risk that provides certainty to parties entering a commercial transaction.
• "[T]he warranty against rightful claims applies to all claims of infringement that have any significant and adverse effect on the buyer's ability to make use of the purchased goods, excepting only frivolous claims that are completely devoid of merit."
• Summary judgment against the plaintiff's warranty claim was inappropriate due to triable issues of fact as to whether the underlying infringement claim was nonfrivolous.
• Triable issues of fact precluding summary judgment also existed as to whether any damages such as Pacific Sun's litigation expenses were proximately caused by Olaes' failure to disclose the potential trademark claims by SNCL. The factual issues include whether Pacific Sun knew of the potential claims.
  
  

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Even Reasonable and Narrow Non-Compete Agreements Are Barred by California Statute

Employment contracts with non-competition clauses are common outside of California, but a California statute, section 16600 of the California Business and Professions Code, prohibits non-compete contracts outside of a few statutory exceptions. In a decision issued on August 7, 2008, Edwards v. Arthur Anderson, No. S147190, the California Supreme Court held that section 16600 prohibits non-competition contracts even if the non-compete clause is reasonable or imposes only a “narrow restraint.” The Court further held that the employer had engaged in a wrongful act by requiring the employee to sign a release of claims under the non-competition contract.

Background:

Section 16600 provides that

“Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”

Statutory exceptions to section 16600 allow non-compete contracts in certain circumstances, including in connection with the sale of goodwill of a business (§ 16601) and the dissolution of a partnership (§ 16602) or limited liability corporation (§ 16602.5).

In Edwards, the plaintiff Edwards had signed a non-competition agreement as an employee of Arthur Anderson. The agreement barred Edwards from serving within 18 months any Anderson clients with whom Edwards had worked, and barred solicitation of clients of Anderson’s Los Angeles office. After Anderson became embroiled in the Enron scandal, HSBC sought to hire a group of employees including Edwards. HSBC and Anderson required the moving employees to sign a “Termination of Non-Compete Agreement” which released “any and all” claims against Anderson. Edwards refused to sign the termination agreement because he did not want to release indemnity claims against Anderson, and was therefore not hired by HSBC. Edwards then sued Anderson and HSBC for claims including interference with prospective economic advantage. Edwards lost in the trial court against Anderson but won at the California Court of Appeal (click here for a discussion of the lower court decision). The California Supreme Court then took the case.

California Supreme Court Holdings:

• The first question before the California Supreme Court was whether Anderson’s enforcement of the non-competition agreement (by forcing Edwards to sign an agreement terminating it) was a wrongful act. The Court held that enforcing the non-competition agreement was illegal under section 16600 and enforcing it was a wrongful act that could lead to liability for interference with prospective economic advantage. The Court noted that

  section 16600 reflects “a settled legislative policy in favor of open competition and employee mobility, . . . [it] ensures that every citizen shall retain the right to pursue any lawful employment and enterprise of their choice [and it] protects the important legal right of persons to engage in businesses and occupations of their choosing.”



• In light of the broad statutory language of section 16600 and the limited statutory exceptions, the Court rejected decisions of federal courts which had ruled that section 16600 allowed “reasonable” non-compete contracts that imposed only a “narrow restraint” on competition. The Court stated “Section 16600 is unambiguous, and if the Legislature intended the statute to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect.”


• In a second part of the decision unrelated to the non-competition agreement issue, the Court also held that the release sought by Anderson as the employer for “any and all” claims was not unlawful because it could not be interpreted to release non-waivable employee indemnity rights under California Labor Code section 2802(a).
  

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Proposed Legislation Would Provide Copyright Protection for Fashion Designs

Proposed Legislation: Senate Bill 1957, Design Piracy Prohibition Act

The One Sentence Summary: The proposed Design Piracy Prohibition Act would provide copyright protection to fashion designs, whereas existing law only protects fashion labels from being copied by counterfeit merchandisers.

Summary of Legislation:

• Senate Bill 1957 would provide copyright protection to a "fashion design," which is defined as "the appearance as a whole of an article of apparel, including its ornamentation."
• The "apparel" entitled to fashion design protection includes clothing (undergarments, outerwear, gloves, footwear, and headgear), handbags, purses, tote bags, belts, and eyeglass frames.
• The period of copyright protection provided would be three years for fashion designs.
• Fashion designs not subject to protection under Senate Bill 1957 include those embodied in a useful article that was made public by the designer or owner more than three months before applying for copyright registration.
• Senate Bill 1957 would also make fully applicable to fashion designs the doctrines of secondary infringement and secondary liability.
• This proposed legislation has sparked considerable debate within the fashion industry. Opponents of the bill, such as the California Fashion Association, contend that it would stifle creativity in the fashion industry and result in more litigation because of difficulties identifying what constitutes a violation of the act. Supporters of the bill, such as the Council of Fashion Designers of America, argue that it would protect against l0w-end knock-offs profiting from fashion designers' creativity.

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Ninth Circuit Affirms Preliminary Injunction for Albertson's Restraining Competing Retail Grocer from Using "Lucky" Trademark

Case: Grocery Outlet Inc. v. Albertson's Inc., No. 06-16380 (9th Cir. 8/9/07)

The One Sentence Summary: Ninth Circuit affirmed the district court's granting of a preliminary injunction to Albertson's, based on the possibility of irreparable injury and the strong likelihood of its prevailing on the merits despite competitor Grocery Outlet's asserted defense of abandonment of "Lucky" trademark by nonuse.


What They Were Fighting About: Grocery Outlet, a competitor of Albertson's in the retail grocery industry, contended that Albertson's abandoned the "Lucky" trademark by publicly announcing after a 1999 merger that "Lucky" stores were being converted to Albertson's stores. Albertson's sought a preliminary injunction for trademark infringement in the Northern District of California to restrain Grocery from using the "Lucky" mark. The district court granted the motion, finding at the preliminary injunction stage that Albertson's legally owned the "Lucky" mark and rejecting Grocery's abandonment defense. Grocery appealed.

Court Holdings:

• Ninth Circuit held that the district court did not abuse its discretion in finding that Albertson's demonstrated a strong likelihood of success on its trademark infringement claim and the possibility of irreparable injury in the absence of a preliminary injunction.
• On appeal, Grocery did not dispute that its use of the "Lucky" mark for retail grocery services was likely to cause consumer confusion. Thus, whether Albertson's was likely to succeed on the merits turned on whether Grocery's abandonment defense would be successful.
• Abandonment by nonuse is a defense under the Lanham Act that requires proof of both the mark owner's discontinuance of trademark use and intent not to resume such use.
• Ninth Circuit concluded that Albertson's offered sufficient evidence of its intent, during the short period of alleged nonuse, to resume use of the "Lucky" mark within the reasonably foreseeable future. Accordingly, the district court did not abuse its discretion in rejecting Grocery's defense of abandonment at the preliminary injunction stage.
• On the standard of proof for the abandonment defense, Grocery adopted the clear and convincing evidence standard in its briefing in the district court. The Ninth Circuit found Grocery to have waived any challenge on this point and decided not to resolve the disputed issue of whether the standard of proof is preponderance of the evidence or clear and convincing evidence.
• Two circuit judges agreed with the court's per curiam opinion but wrote separate concurring opinions to express their divergent views on the standard of proof for an abandonment defense under the Lanham Act. While the court's per curiam opinion did not discuss the issue, the concurring opinions provide future litigants in Ninth Circuit courts with their legal arguments for either a preponderance of the evidence or a clear and convincing evidence standard of proof.

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Ninth Circuit Reverses Denial of Retailer's Motion for Preliminary Injunction in Trademark Infringement Case

Case: Abercrombie & Fitch Co. v. Moose Creek, Inc., No. 06-56774 (9th Cir. 5/22/07)

The One Sentence Summary: District court erred in denying Abercrombie & Fitch's motion for a preliminary injunction against Moose Creek's use of new marks by (1) misapplying the doctrine of judicial estoppel, and (2) erroneously concluding that the parties' trademarks were more different than similar.

What They Were Fighting About: Abercrombie & Fitch filed suit in August 2005 against Moose Creek for alleged trademark infringement, unfair competition, and false designation of origin under the Lanham Act and various California common law claims, one year after the parties settled a 2004 trademark infringement suit brought by Moose Creek. In the later action Abercrombie contended that Moose Creek's two new logos, a moose silhouette and a moose outline, infringed on Abercrombie's similar marks. Abercrombie moved to enjoin Moose Creek's use of its new marks pending resolution of the lawsuit. District court denied Abercrombie's motion because it concluded that (1) a number of Abercrombie's arguments were contrary to its positions in the prior litigation and therefore barred by judicial estoppel, and (2) differences between the parties' marks outweighed the similarities.

Ninth Circuit Holdings: The Ninth Circuit reversed and remanded the case to the district court for reconsideration of Abercrombie's motion for a preliminary injunction, because:

• Applying the Sleekcraft factors regarding likelihood of confusion, the district court abused its discretion in finding that Abercrombie was judicially estopped to assert arguments about the strength of Moose Creek's marks and the degree of care likely to be exercised by the purchaser.


• The district court also erred in estopping Abercrombie from arguing post-purchase confusion as a ground for trademark infringement.


• Judicial estoppel does not apply where the party's later litigation position is not "clearly inconsistent" with its earlier litigation position.


• With respect to the third Sleekcraft factor - similarity of the marks - the district court clearly erred in concluding that differences between the parties' marks outweighed similarities. District court erroneously relied on comparisons to Moose Creek's marks as they appeared in a catalog, rather than as they appeared embroidered on the company's apparel in the marketplace. Ninth Circuit noted that "marks must be considered in their entirety and as they appear in the marketplace."

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