As I noted in Supreme Court lets ban on “gray market” imports stand, the Supreme Court has upheld a ban on unauthorized “gray market” imports (see my previous related discussion in Leveraging IP). C4SIF board member Wendy McElroy has a superb piece on this in the latest issue of The Freeman:

The Free Life | Wendy McElroy

Ominous Copyright Ruling Stands

The right to resell is undermined.

Posted December 21, 2010
Print This Post • 0 comments

A stunning but little-noticed Supreme Court ruling signals that the face of business and the boundaries of ownership could soon change dramatically. The December 13 ruling in Costco Wholesale Corp. v. Omega S.A. is little-noticed because as a 4-to-4 decision, with one Justice recused, it merely affirmed a lower-court decision without setting a national precedent. What it signals is how all but one Justice would rule on the “first-sale” doctrine within copyright law.

Omega is a Swiss watch manufacturer. Costco is an American retailer known for selling brand-name goods at deep discount.  Its business model includes the common arbitrage practice of “parallel importation” by which a commodity selling more cheaply abroad than domestically is imported and marked up by an unauthorized seller. A New York-based supplier imported Omega watches and resold them to Costco. Although each step of acquisition was legal, Omega sued because Costco was  not “authorized” to distribute its copyrighted logo.

The suit challenged the legal doctrine of “first-sale,” recognized in 1908 by the Supreme Court in Bobbs-Merrill Co. v. Straus and codified in the Copyright Act of 1976. Under this doctrine the buyer of a copyrighted work can dispose of it without permission of the copyright holder. For example, you can sell used books without permission from authors or publishers. Because there is a low threshold for copyright registration, first-sale applies to a vast array of products, from breakfast cereals to kitchen appliances, from beauty aids to vitamins. It also applies to foreign parts used in assembling otherwise American goods.

In February 2007 a federal district court in California granted Costco’s motion for summary judgment vacating Omega’s preliminary injunction. Omega appealed to the Ninth Circuit Court, where a three-judge panel reversed the lower court and ruled that the first-sale defense applies only to items made and distributed within the United States and not to foreign goods. This is the ruling the Supreme Court affirmed. Costco now returns to the lower courts where the case has been remanded for further proceedings.

The Tie-Breaking Justice

The Supreme Court Justice who recused herself is Elena Kagan. There is reason to think she would have voted against first-sale.  In its ruling the Ninth Circuit argued that applying first-sale to foreign goods would violate a presumption against imposing U.S. law in an extraterritorial manner. Costco countered that preventing a foreign company from controlling distribution within the U.S. did not involve extraterritoriality. However, Kagan, as solicitor general for the Obama administration, submitted a friend-of-the-court filing (pdf) that raised extraterritoriality concerns, stating that the “Copyright Act does not apply outside the United States.”

In short, if another foreign manufacturer takes a similar case to the Supreme Court, a 5-4 vote against first-sale for foreign goods is highly probable. Then, as the Ninth Circuit stated, a foreign manufacturer would be able to “exercise distribution rights after even the tenth sale in the United States….”

Among the likely effects of the ruling:

• a huge array of goods will lose first-sale exemption;
• some American manufacturers will relocate abroad to enjoy lucrative copyright and distribution advantages;
• domestic manufacturers will be vulnerable to “downstream restraints” due to foreign components in their products;
• possible lawsuits and fines will encourage manufacturers to “Buy American,” raising costs to consumers;
• the practice of protecting otherwise unremarkable foreign goods by attaching a copyrighted logo or label will proliferate;
• Parallel importing will cease or be severely restricted, making American retailers less profitable and goods more expensive;
• American consumers will lose the legally clear right to sell or loan personal goods that were produced in other countries or contain foreign parts.

The stakes are not trivial. In 2009, according to the U.S. Department of Commerce, American businesses imported $1.6 trillion in foreign-made goods. But the stakes are more than economic. The denial of first-sale to foreign goods also upsets hundreds of years of common-law tradition determining an individual’s control of his personal property.

Nevertheless, with such a rich plum of possibility hanging over the Supreme Court, it is difficult to believe that another foreign manufacturer will not attempt to secure the benefits signaled by Costco Wholesale Corp. v. Omega S.A.