Parallel Imports and the Principle of Exhaustion: The First Sale Rule in International Commerce

Kyle C. Williams

 

The lack of harmony in international trade law regarding parallel imports of goods that are protected by intellectual property (IP) rights has created challenges for IP owners doing business in foreign markets. Many jurisdictions differ with respect to the policies and laws prohibiting or allowing parallel imports of goods protected by intellectual property rights.[1] However, preventing IP owners from using their rights to monopolize the re-sale of protected products from third parties can benefit fair trade and competition policy. Because each jurisdiction differs in policy, IP owners must consider the law of the jurisdiction where a potential licensee/distributor operates for the sale of a protected product to determine whether its products may be re-sold in competition with the IP owner in their domestic market.[2] The principle of exhaustion of intellectual property rights will determine whether an IP owner may prevent a third-party purchaser re-selling a product as a parallel import in the IP owners’ domestic market.

 

International jurisdictions have trade policies that follow the principle of either national exhaustion or international exhaustion regarding the extent of intellectual property rights after a particular product has reached the market.[3] Under a national exhaustion regime, the IP owner loses the right to restrict trade of a product using its protected IP in the country where it was first put into commerce.[4] However, the IP owner reserves the right to restrict the first sale of a product using its protected IP in any other jurisdiction.[5] This form of the principle allows for the IP owner to maintain control over their rights and retain the ability to authorize re-sale in exchange for additional compensation in a licensing agreement with a foreign distributor/manufacturer.

 

Under an international exhaustion regime, the IP owner loses the right to restrict trade of a product using its IP after it has first been put to commerce wherever the product has been sold. This form of the exhaustion principle effectively prohibits the IP owner from preventing third-parties from re-selling their products both abroad and in the IP owners’ domestic market.[6] Intellectual property law in the US provides the IP owner with the exclusive right to benefit from the sale of a protected product in most cases. Once the first sale rule has been met, however, the policies of the jurisdiction where the product was sold dictate whether those rights remain in effect.[7] The adoption of the first sale rule can stimulate growth within the market by supporting competition and a stable price for many protected consumer goods.

 

1. Intellectual Property Rights and Parallel Importation

 

Despite the attempt to establish uniformity of intellectual property rights internationally, regulation of parallel imports has not been consistent amongst many of the world’s most prominent international partners. Trademark, patent, and copyright law in the US, for example, each address the issue of parallel imports differently. Moreover, Article 6 of the agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) asserts that the issue of exhaustion shall not be addressed by the agreement.[8] The consequence is that each jurisdiction on the international stage will decide whether to have a national exhaustion regime or an international exhaustion regime. The US applies an international exhaustion regime through the use of the first sale rule, requiring IP owners to rely on other mechanisms to address parallel imports.

 

2. US Trademark Protection against Parallel Imports

 

Trademark Law in the US limits the tools available for IP owners to protect against parallel imports. In Matrix Essentials, Inc., the Fifth Circuit held that liability under trademark infringement is predicated on a finding that the infringers’ activities are likely to cause confusion.[9] In order to find infringement, the consumer must either be misled with respect to defects in the goods or be confused regarding whether the seller is authorized by the manufacturer/IP owner to sell the goods purchased in good faith.[10]

 

Citing Shell Oil Co., the fifth circuit agreed that trademark law does not usually apply to the sale of genuine goods that contain the mark of the legal IP owner even if those sales are conducted without the IP owners’ consent.[11] Thus, if the goods are not counterfeit, were acquired legally, contain the IP owners mark, and fit the quality control standards of the IP owner, there can be no infringement for re-sale.[12]

 

US trademark law does provide protection for IP owners through the Lanham Act. When goods sold through a third-party are protected by the original IP rights, and are materially different from those sold by the IP owner, the Lanham Act provides a remedy for cases of infringement.[13] Section 32(1) creates a remedy for the use of civil actions against infringement of registered trademarks.[14] Section 42 allows the customs and border patrol to prevent imports of goods that infringe both registered and unregistered trademarks.[15] Section 43(b) allows a party to create a civil action to enjoin importation of any goods that are likely to infringe on a registered or unregistered trademark.[16] Courts in the US have found that even subtle differences are enough since the standard is a low bar.[17] However, these protections do not solve for the re-sale of identical goods put into the domestic market.

 

Additional federal statutory protection against parallel imports exist in the 1930 Tariff Act. Section 526 of the Act blocks parallel imports of goods protected under a trademark owned by a US person without written consent, regardless whether the goods are identical or materially different.[18] However, Section 526 only applies to goods manufactured outside the US, and does not apply when the US person who owns the trademark also owns a trademark for the goods in the manufacturing country, or a corporate affiliation with a foreign manufacturer.[19] Thus, Section 526 may protect a US IP owner of a registered trademark from parallel imports sold in their domestic market as a biproduct of a licensing agreement with a foreign distributor, but will not protect against third-party sales if the foreign distributor is a parent or subsidiary corporation of the IP owner.

 

3. US Copyright Protection against Parallel Imports

 

Under the Copyright Act, the owner or exclusive licensee of a federal copyright maintains the exclusive right to import and distribute materials using that copyrighted material in the United States.[20] However, the first sale rule limits this right of importation and distribution by only providing the IP owner the right to control the first public sale, while granting no rights over subsequent resales of the same copyrighted material.[21] US courts had differing opinions as to whether the Copyright Act protected against the resale of copyrighted products if those products were manufactured abroad until the US Supreme Court addressed this issue in Kirtsaeng.

 

Court in Kirtsaeng held that the first sale rule applies to goods protected by US Copyright Law regardless of whether the goods were manufactured in the US or abroad.[22] The Court found that because the product was brought to sale by the IP owner, and because there are no geographical restrictions on where the first sale rule applies, the IP owner/manufacturer could not prevent Kirtsaeng from creating a parallel import of the copyrighted material.[23] Thus, the rationale of the first sale rule would apply in any jurisdiction after the IP owner put the goods to market anywhere in the world. Therefore, Copyright Law in the US also provides limited protection against parallel imports.

 

4. US Patent Law Protection against Parallel Imports

 

Under 35 U. S. C. §154(a) a US Patent holder has the right to “exclude others from making, using, offering for sale, or selling [its] invention throughout the United States or importing the invention into the United States.”[24] The Supreme Court, however, has affirmed in Impression Products, Inc. that once the patentee sells one of its protected products the patentee can no longer control the patented item through the patent laws because those rights will have been exhausted.[25] The Court reasoned that because the purpose of patent law is for the patentee to receive his/her reward for the use of his/her invention, that law furnishes “no basis for restraining the use and enjoyment of the thing sold.”[26] Thus, the first sale rule extends to all applicable intellectual property rights provided by US federal law. Protection against parallel imports is therefore limited in the jurisdiction of the United States.

 

5. International Law and Parallel Imports

 

Most nations around the world utilize an international exhaustion regime. However, many nations include specific variations on the core principle. The United States and Canada, for example, both use an international exhaustion regime based on a standard of whether the parallel import is materially different from the IP owner’s original product.[27] If no material differences are found then the product may be imported into the country subject to national competition law by state or province.[28]

 

Some nations and international blocs have national exhaustion regimes within their borders. For example, the European Union (EU) prohibits IP owners from restricting the trade of parallel imports within its member states, while requiring each member state to block parallel imports from outside the EU.[29] The EU prohibits any individual member state from operating an international exhaustion regime in an effort to promote free trade policies amongst its member states while restricting foreign trade.[30] Similar to the examples set by North America and Western Europe, most nations apply a national or international exhaustion regime under the first sale rule to address parallel imports and IP rights.

 

6. International Exhaustion Regimes

 

Many prominent players in international trade operate within an international exhaustion regime. Australia, Singapore, China, Hong Kong, and Japan all operate within this type of regime. Although all of these nation states follow the international exhaustion principle, they all approach the policy differently.

 

Under Section 123 of the Australian Trademarks Act 1995, a parallel importer may claim a defense to trademark infringement if the goods have been legally marked by the IP owner, or if the mark was applied with the IP owners’ consent.[31] Under Schedule 2 to the Competition and Consumer Act 2010, IP owners may protect against trademark infringement where the parallel importer makes a false representation regarding a performance characteristic, use, benefit, warranty, guarantee, or country of origin information that is different from the actual IP owners product.[32] This is similar to the “material differences” standard used in North America to prove infringement.

 

China does not currently have legislation in place to regulate parallel imports, but Chinese customs may prevent physical goods from entering the country that violate Customs protection of intellectual property rights.[33] China has avoided many cases regarding parallel imports in its courts because multinational corporations usually manufacture products in China and export them into other jurisdictions.[34] The low cost of manufacturing goods in China helps to prevent most parallel importers from purchasing goods at a lower price elsewhere and selling them into China.[35] At present, parallel imports freely exist without restriction in the Chinese market, so the nation can be considered to be under an international exhaustion regime by proxy. However, without clear legislation or binding case law precedent, a definitive regime cannot be established.[36]

 

In contrast to the ambiguity for treatment of parallel imports in mainland China, Hong Kong has a relatively clear international exhaustion regime. With respect to trademark law, Hong Kong mirrors the first sale rule of the United States in that it looks to whether the protected goods have been altered from the original standard put to market by the IP owner, and whether the goods will harm the distinctive character of the trademark.[37] Upon the enactment of a revised copyright law in 2007, Hong Kong now includes a far more protectionist standard against parallel imports for goods under copyright than with trademarks.

 

It is an actionable offense in Hong Kong to sell imported parallel copies of goods protected by copyright for any business purpose to the public, unless the good is computer software.[38] Additionally, the importation of genuine goods for educational purposes is allowed as a form of fair use within its borders.[39] Hong Kong also provides a criminal action as a remedy if a party sells, or imports for sale, goods that are protected by copyright (with exceptions for computer software, within the previous 15 months of the import.)[40] A criminal action is also available for the parallel import of protected motion pictures made available to a viewing public.[41] Thus, Hong Kong has a hybrid international exhaustion regime.

 

In Japan, the so-called “Fred Perry” case, heard by the Supreme Court of Japan, established the rule on parallel imports in that jurisdiction. In the Fred Perry case, a party brought suit against a parallel importer after goods associated with a valid international licensing agreement entered into the Japanese market in competition with the IP owner of the marks used for those goods. The Supreme Court of Japan held that if the goods sold in the domestic market are genuine goods produced with the consent of the IP owner, from an identical source and with identical quality, the parallel import cannot violate Japanese trademark rights.[42] Therefore, parallel imports in Japan follow the international exhaustion regime under a version of the first sale rule.

 

7. National Exhaustion Regimes

 

Although most industrious nations follow some form of international exhaustion for the regulation of parallel imports using IP rights, some follow the national exhaustion model despite the global focus on free trade policy. The Philippines and Russia, both hybrid national exhaustion regimes, maintain protectionist policies regarding the creation of parallel distribution channels for IP protected products.

 

The Philippine system is a hybrid national regime because only copyright and patent IP owners may restrict parallel imports, while trademark IP owners must endure competition from parallel distribution channels.[43] Trademark law in the Philippines permits the importation of genuine products sourced from the IP owner of the mark used on a given product.[44] The law does, however, prohibit the copying or simulation of trademarked goods.[45] In Solid Triangle Sales Corp. v. The Sheriff of RTC Quezon City, the Supreme Court of Manila held that only in cases of fraud or deceit may a parallel importer be found liable of unfair competition based on whether the imported product is passing off as something different.[46]

 

Section 190 of the IP Code authorizes the importation of copyright protected works, where the IP owner is a domestic producer, only when the work is not available in the Philippines and is in the personal luggage of a natural person.[47] Additionally, the amount of copies must not exceed three in total.[48] The law does not, however, address commercial quantities of genuine goods under protection of copyright law.[49] Thus, the courts may have discretion to determine the fate of a parallel importer that has been accused of copyright infringement.

 

Patent law in the Philippines is much more concrete regarding parallel imports of IP protected products. Where the subject matter of the patent is a product, the IP owner maintains the right to restrict an unauthorized person or entity from making, using, offering for sale, selling, or importing that product.[50] Although there are limitations on an IP owners’ rights after the protected product has been put to sale, those rights only effect domestic producers, not foreign distributors.[51] Thus, Philippine patent law maintains a national exhaustion regime with respect to most of its IP rights related to the activity of parallel importation.

 

Maybe insert a more concrete transition into talking about Russia? For many years, parallel imports of IP protected goods into the Russian market were prohibited and considered counterfeit.[52] If parallel goods were caught by customs agents they would be confiscated for a period of 10 days allowing for the Russian IP owner to execute a civil suit to have them destroyed following payment of court ordered damages.[53] In 2018, the Russian Constitutional court held that although there is a conflict of interest between IP trademark owners and parallel importers, Russia maintains a policy of national/regional exhaustion of IP protection, so parallel imports are prohibited.[54]

 

Russian courts have, however, begun the process of liberalizing the policy against parallel importation. The Constitutional Court has also held that IP owners should be barred from abusing their rights by restricting the import of goods that meet unique public interests.[55] The courts have also used their discretion in judgements to lower damages for cases of parallel imports of genuine goods rather than making damages equal to a judgement for the sale of counterfeit goods.[56] As a member of the Eurasian Economic Union, there is international exhaustion between the member states, but like the EU, a practice of national exhaustion applies to all foreign parallel imports.[57]

 

8. Rationale and Policy Considerations

 

Globalization has sparked a wildfire of free trade policy across the industrial world. Naturally, to promote free trade policy, the sale of goods must be allowed to move between markets with minimal restraint. However, producers must have a means to protect themselves and their work product. Intellectual property rights provide one mechanism to protect those interests. On the other hand, IP rights offer an opportunity to abuse free market principles by promoting activity that restricts healthy competition.[58] Adopting a policy of exhaustion is an attempt to regulate the potential abuse of IP rights while protecting foreign and domestic producers.

 

Parallel importation on the global market does provide a nuisance to IP owners, but there is great benefit in promoting the activity. Owners of IP bring a product to market with set prices and launch dates. This activity allows producers to exert a large amount of control over consumer access and competition in the region where sales are being executed by effectively promoting market segmentation.[59] Thus, the decision to use either an international or national/regional exhaustion regime for IP rights reflects economic competition policy of the country in question. Therefore, the strength of the domestic economy may indicate which regime will evolve in that country.

 

Intellectual property rights confer a monopoly over what amounts to an intangible asset.[60] This asset may be affixed to any number of physical products that enter the market anywhere in the world. The IP monopoly is intended to provide the IP owner the right to profit off of its inventive work product, but under the principle of exhaustion that monopoly does not extend past the sale of an individual product that has been affixed with the protected IP after it has been put into commerce.[61] This restriction on the extension of IP rights to prevent parallel imports preserves an important  channel for commerce that benefits competition and often strengthens the international economy.

[1] Christopher Heath, Parallel Imports and International Trade, WIPO, July 9, 1999, at 3, par. 1 Available at: https://www.wipo.int/edocs/mdocs/sme/en/atrip_gva_99/atrip_gva_99_6.pdf

[2] Michala Meiselles, Hugo Wharton, International Licensing Agreements: IP, Technology Transfer and Competition Law, 32-34, par. 4 (2018) Available at: https://play.google.com/books/reader?id=QI6WDwAAQBAJ&hl=en&pg=GBS.PT38.w.6.0.61

[3] Fabio Giacopello, Parallel import: The Battle Between Safe and Cheap, HFG Law & Intellectual Property, Last updated: 3 Apr. 2019, at 1, par. 5 Available at: http://www.hfgip.com/news/parallel-import-battle-between-safe-and-cheap

[4] Id.

[5] Id.

[6] Id.

[7] Mary LaFrance, Wag the Dog: Using Incidental Intellectual Property Rights to Block Parallel Imports, 20 Mich. Telecomm. & Tech. L. Rev. 45, 51 (2013). Available at: http://repository.law.umich.edu/mttlr/vol20/iss1/2

[8] TRIPS: Agreement on Trade-Related Aspects of Intellectual Property Rights, Apr. 15, 1994, Marrakesh Agreement Establishing the World Trade Organization, Annex 1C, 1869 U.N.T.S. 299, 33 I.L.M. 1197, Art. 6 (1994) Available at: https://www.wto.org/english/docs_e/legal_e/27-trips.pdf

[9] Matrix Essentials, Inc. v. Emporium Drug Mart, Inc., of Lafayette, 988 F.2d 587, 590 (5th Cir. 1993)

[10] Id.

[11] Id.

[12] Id.

[13] Mary LaFrance, Wag the Dog: Using Incidental Intellectual Property Rights to Block Parallel Imports, 20 Mich. Telecomm. & Tech. L. Rev. 45, 52 (2013) Available at: http://repository.law.umich.edu/mttlr/vol20/iss1/2

[14] 15 U.S.C. § 1114(1) (2012)

[15] Id.

[16] Id.

[17] Mary LaFrance, Wag the Dog: Using Incidental Intellectual Property Rights to Block Parallel Imports, 20 Mich. Telecomm. & Tech. L. Rev. 45, 53 (2013) Available at: http://repository.law.umich.edu/mttlr/vol20/iss1/2

[18] 19 U.S.C. § 1526 (2012)

[19] Mary LaFrance, Wag the Dog: Using Incidental Intellectual Property Rights to Block Parallel Imports, 20 Mich. Telecomm. & Tech. L. Rev. 45, 55 (2013) Available at: http://repository.law.umich.edu/mttlr/vol20/iss1/2

[20] 17 U.S.C. § 602(a)(1) (2012)

[21] Mary LaFrance, Wag the Dog: Using Incidental Intellectual Property Rights to Block Parallel Imports, 20 Mich. Telecomm. & Tech. L. Rev. 45, 58 (2013) Available at: http://repository.law.umich.edu/mttlr/vol20/iss1/2

[22] Kirtsaeng v. John Wiley & Sons, Inc., 568 U.S. 519, 553, 133 S. Ct. 1351, 185 L. Ed. 2d 392 (2013)

[23] Id.

[24] 35 U. S. C. §154(a)

[25] Impression Prod., Inc. v. Lexmark Int’l, Inc., 137 S. Ct. 1523, 1531, 198 L. Ed. 2d 1 (2017)

[26] Id. at 1532.

[27] Impression Prod., Inc. v. Lexmark Int’l, Inc., 137 S. Ct. 1523, 1531, 198 L. Ed. 2d 1 (2017); Dupont of Canada Ltd. v. Nomad Trading Co. (1968) 55 CPR 97

[28] Id.

[29] Mary LaFrance, Wag the Dog: Using Incidental Intellectual Property Rights to Block Parallel Imports, 20 Mich. Telecomm. & Tech. L. Rev. 45, 76 (2013). Available at: http://repository.law.umich.edu/mttlr/vol20/iss1/2

[30] Id.

[31] Trade Marks Act 1995, (Cth) s 123 (Austl.)

[32] Competition and Consumer Act 2010 (Cth) sch. 2 (Austl.); Star Micronics Pty Ltd. v. Five Star Computers Pty Ltd. (1991) 22 IPR 473

[33] Article 3, Regulations of the People’s Republic of China on Customs Protection of Intellectual Property Rights (2004) Available at: https://www.wipo.int/edocs/lexdocs/laws/en/cn/cn025en.pdf

[34] Daniel Chow, Exhaustion of Trademarks and Parallel Imports in China, 51 Santa Clara L. Rev. 1283, 1286 (2011). Available at: http://digitalcommons.law.scu.edu/lawreview/vol51/iss4/7

[35] Id.

[36] Id. at 1309.

[37] Section 20, Trade Marks Ordinance (Cap. 559 of the Laws of Hong Kong)

[38] Copyright Ordinance (Cap. 528 of the Laws of Hong Kong)

[39] Angela Wang & Co, Parallel Importation of Goods in Hong Kong and Mainland China (Part I – Hong Kong), MONDAQ, Last updated: 25 Feb. 2008, at 1, par. 11 Available at: http://www.mondaq.com/article.asp?article_id=57560

[40] Id.

[41] Id.

[42] Case H14 (Ju) 1100, Judgment on February 27, 2003 (H15) Available at: https://www.jpaa.or.jp/old/english/court_decisions/69FREDPERRYCase.pdf

[43] Ignacio S Sapalo, PHILIPPINES: PARALLEL PROBLEM, SVBB, 01 October 2007, at 1, par. 2, Available at: https://www.sapalovelez.com/2014/08/27/philippines-parallel-problem/

[44] Section 166 of Republic Act 8293, the Intellectual Property Code (IP Code)

[45] Id.

[46] Solid Triangle Sales Corp. v. The Sheriff of RTC Quezon City, Branch 93, 370 SCRA 509 Available at: http://www.chanrobles.com/scdecisions/jurisprudence2001/nov2001/gr_144309_2001.php

[47] Ignacio S Sapalo, PHILIPPINES: PARALLEL PROBLEM, SVBB, 01 October 2007, at 1, par. 8, Available at: https://www.sapalovelez.com/2014/08/27/philippines-parallel-problem/

[48] Id.

[49] Id.

[50] Section 71(a), Rep. Act No. 8293 (Intellectual Property Code), as amended by Rep. Act No. 9502 Available at: https://PH_Intellectual-Property-Code-of-the-Philippines-Republic-Act-No-8293-2015-Edition.pdf

[51] Ignacio S Sapalo, PHILIPPINES: PARALLEL PROBLEM, SVBB, 01 October 2007, at 1, par. 10, Available at: https://www.sapalovelez.com/2014/08/27/philippines-parallel-problem/

[52] Olga Yashina, Russian Federation: Parallel Imports In Russia: Same Game, Different Rules, MONDAQ, Last updated: 3 December 2018, at 1, par. 1, Available at: http://www.mondaq.com/russianfederation/x/760194/Trademark/Parallel+imports

[53] Id.

[54] Id. at 8.

[55] Id. at 10.

[56] Id at 12.

[57] Id. at 16.

[58] E. Bonadio, Parallel Imports in a Global Market: Should a Generalized International Exhaustion be the Next Step?, European Intellectual Property Review, 33(3), 1 (2011) Available at: https://openaccess.city.ac.uk/id/eprint/4106/1/Parallel Imports in a Global Market.pdf;Exhaustion

[59] Keith E. Maskus, Economic Perspectives on Exhaustion and Parallel Imports, CALBOLI 9781783478705 PRINT (M3966) (G).indd, 106 (2016) Available at: https://www.colorado.edu/faculty/kmaskus/sites/default/files/attached-files/chapter_6.pdf

[60] E. Bonadio, Parallel Imports in a Global Market: Should a Generalized International Exhaustion be the Next Step?, European Intellectual Property Review, 33(3), 1 (2011) Available at: https://openaccess.city.ac.uk/id/eprint/4106/1/Parallel Imports in a Global Market.pdf;Exhaustion

[61] Id.