A Different Shade of Gray: The Scope and Limits of Gray Market Goods and Recent Developments in the Cosmetics Space

Under the first sale doctrine, once a trademark owner first authorizes its branded product to be sold to a consumer, the trademark owner’s right to control the further re-sale of that product is generally said to be “exhausted”, so long as the product is not “materially different” from the original.

A corollary to the first sale doctrine is the concept of gray market goods (sometimes referred to as parallel imports).  Gray market goods are those that are genuine, branded products that are first sold by a trademark owner in another country and then imported to the U.S. by a third-party (without the trademark owner’s consent) and are usually sold at a lower price than the U.S. version of the product.

Section 526 of the Tariff Act prohibits the importation of trademarked goods without the explicit written consent of the owner.  Section 42 of the Lanham Act, 15 U.S.C.A. §1142, establishes authority for U.S. Customs Service to prevent entry of gray market goods into the United States.  Section 42 applies to goods that are physically and materially different from the domestic product, and thus are likely to cause consumer confusion.  Thus, like the first sale doctrine, such unauthorized importation/sale of gray market goods is permitted so long as the products are not “materially different” from the U.S. version.  The challenge for brand owners lies in persuading courts that the differences are in fact “material.”

For decades, courts have wrestled with the question of what constitutes a material difference in the fashion and cosmetics space.  For example, the court in Davidoff & Cie, S.A. v. PLD International Corp. found that selling fragrance products with the batch codes removed and replaced with numbers that did not correspond to any actual products was a material difference and affirmed a decision to grant plaintiff’s request for a preliminary injunction.[1]  Similarly, in John Paul Mitchell System v. Pete-N-Larry’s, Inc., the court held that “physical obliteration of the batch codes” on Defendant’s gray market hair-care products was a material difference.[2]

In contrast, the court in Matrix Essentials v. Emporium Drug Mart found that Defendant’s gray market hair-care products were identical to Plaintiff’s products despite Defendant’s circumvention of certain quality control functions within Plaintiff’s distribution system, and because there was no apparent or potential “defect” in the product that consumers would not be able to easily detect.[3]

In a more recent case, Dermalogica brought a civil action against Target for Target’s alleged unauthorized importation and sale of gray market goods bearing Dermalogica’s trademarks.  Dermalogica alleges that the products sold in Target’s stores are gray market goods from Canada and are materially different from Dermalogica’s U.S. products because 1) the Canadian product does not comply with FDA labeling requirements; 2) the product packaging in the United States provides that the product offers “UVA high protection” at a SPF grade 50, whereas the Canadian product does not; 3) The product packaging in the United States provides a “DRUG FACTS” section that includes “uses” and “directions” as required by the FDA, and these items are not included in the Canadian product; 4) The product packaging in the Canadian product includes different language to describe the product’s characteristics, and includes a French translation, whereas the United States product does not; and 5) The product packaging for the Canadian product does not direct consumers to call the toll-free phone number for questions and comments, which is an FDA requirement.

Left: Dermalogica Marketing Materials; Right: Target’s Marketing Materials

Dermalogica also alleges that Target’s advertising for the skin-care products is false and misleading in that a consumer would likely believe that the product contains anti-acne products when in fact the products are only intended to be a moisturizer and this would be material to a consumer’s purchasing decision.  Furthermore, Dermalogica alleges that it has an extensive agreement system in place that prohibits the re-sale of such products to others, and this is intended to allow them to maintain quality control and provide consumer updates in the event of a product recall.

Dermalogica alleges Unfair Competition, False Designation of Origin, and False Advertising under the Lanham Act, as well as False Advertising, Tortious Interference with Contractual Relations, Tortious Interference with Prospective Economic Relationships, and Unfair Competition under California law.  Dermalogica seeks a preliminary and permanent injunction as well as damages, and attorney’s fees.

As of the writing of this article, Target has not filed its Answer to the complaint.

Practice tips/takeaways

It is unclear whether courts will take a more expansive view of “materiality” such that trademark owners will be able to more easily stop the importation of gray market goods, or whether courts will retreat to the more narrow view of what constitutes a material difference and permit the importation of gray market goods in all but the most extreme cases, including where there is an actual or apparent defect that is not obvious to a potential consumer. In either case, brand owners should continue to remain vigilant with their brand protection policies and the impact of their global sales.