A Textbook Example of the Grey Market

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Out of the scores of disputes that arise with respect to “grey market” distribution channels, what are the odds that a case involving a Thai student doing business as “bluechristine99” on eBay would reach the U.S. Supreme Court?

“Grey market” refers to the sale of genuine branded products outside of established distribution channels established by a manufacturer. A manufacturer may provide different price structures to different markets and customers.  These price differentials create an opportunity for brokers and distributors to purchase products at discounted rates, but sell them in places where they can realize greater profits – in places not intended by the manufacturer. One example is the sale of on-line prescription drugs from Canadian distributors to individuals located in the U.S. The drug manufacturer sells the medications at a lower wholesale price in Canada; distributors take advantage of that lower price and resell over the internet and ship to U.S., thus undercutting retail prices charged in the U.S.

The “bluechristine99” case decided by the U.S. Supreme Court in March involved a textbook example of the grey market -- literally.  A student at Cornell University, Supap Kirtsaeng, had friends and family purchase English-language textbooks (which had been printed overseas) in Thailand and mail the textbooks to him in the U.S.  Using eBay as his distribution channel, Kirtsaeng re-sold the books at a profit.

The holder of the copyrights in the textbooks, publisher John A. Wiley & Sons, sued Kirtsaeng for copyright infringement, citing its exclusive right to distribute the copyrighted materials in the U.S.  Kirtsaeng asserted a defense based on the “first sale” doctrine of U.S. copyright law. Under that doctrine, the owner of a particular copy of copyright materials lawfully made under U.S. copyright law is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy.

In the Kirtsaeng case, the issue was relatively narrow. The U.S. Supreme Court had previously held that goods manufactured in the U.S. and sold overseas were subject to the first sale doctrine, and thus the manufacturer could not bar subsequent sales of goods re-imported into the U.S. by asserting copyright infringement. In Kirtsaeng, the textbooks had been printed overseas, and not in the U.S.  The District Court and court of appeals found that distinction to be meaningful. But the U.S. Supreme Court did not. It overturned the district court’s finding of copyright infringement against Kirtsaeng, holding that the first sale doctrine defense applied to re-sales of copyrighted materials lawfully produced overseas.

The co-opting of distribution channels by brokers such as Kirtsaeng is only a part of the grey market problem in the distribution industry. Many grey market disputes involve parties who voluntarily have partnered to do business. Distributors and brokers may resort to buying or selling on the grey market for benign reasons (selling excess inventory at below-market prices, acquiring products on the grey market to meet customer demand when the manufacturer cannot deliver) or because they are engaging in more nefarious practices (falsely representing the identity of the end user to obtain additional discounts, exploiting pricing differentials between jurisdictions).

Whatever the reason for the practice, the grey market can damage a manufacturer.  There is the risk that items sold on the grey market are actually low-quality counterfeit goods that wind up disappointing the end user, hurting the goodwill of the legitimate brand and manufacturer.  If the goods aren’t purchased from an authorized dealer, there may be no warranty from the original equipment manufacturer.  Finally, those distributors who buy within established channels suffer financially while those bending the rules are rewarded, damaging the strength of the distribution system.

Addressing these issues can be difficult, especially for manufacturers without significant market power and who rely on large distributors to sell their products.  Contractual protections in distribution agreements are a critical starting point of any effort to curb grey market practices.

Eroding Exclusivity: The Saga of JCP, Macy's and Martha Stewart

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Some observations on the ongoing trial in New York Supreme Court involving Macy’s, J.C. Penney (“JCP”) and Martha Stewart Living Omnimedia (“MSLO”), as the dispute pertains to the franchise and distribution industry:

  • Carveouts to exclusivity clauses should be viewed warily by the party purportedly receiving exclusive rights.  In the Macy’s/JCP/MSLO dispute, MSLO had granted Macy’s the exclusive right to market certain products (such as cookware and bedding) sold by MSLO. The exclusivity clause in the Macy’s/MSLO agreement, however, contained an exception permitting MSLO to sell the products via the internet, television or at any retail store branded with the Martha Stewart Living name and operated by the company or its affiliates or which “prominently” featured the brand.   JCP acquired a minority interest in MSLO; the parties then sought to utilize the exception to Macy’s exclusive retail sale rights by placing MSLO “boutiques” inside JCP stores to sell those same products.
  • Exceptions to exclusivity clauses can be found in many franchise agreements (e.g., outlets located within the territory, but inside airports or malls) and distribution and sales representative agreements (e.g., internet sales, house accounts or national accounts).  If an exception is overly broad or vague, the exception can severely erode the expectation of exclusivity.