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Gray Market Goods - Limiting Warranties

Gray Market Goods – Limiting Warranties

Can a manufacturer limit the product warranty it provides for gray market products and/or refuse to warrant gray market products sold by unauthorized resellers? If so, how should this be communicated to customers and are any best practices that businesses use to minimize the impact gray market products have upon their relationships with valued customers and retailers?

I. What is the Gray Market?

The gray market has been defined as the unauthorized sale of new branded products diverted from authorized distribution channels or imported into a country for sale without the consent or knowledge of the manufacturer. Deloitte LLP estimates that the gray market “siphons as much as $63 billion in US industry sales.” See, Losing $63 Billion to Gray Market is Sleuth Obsession, Bloomberg, July 2006. The problem has increased in the current economy as resales, knock-offs and gray goods are funneled into the market. Some manufacturers have taken measures to discourage the gray market sales of their products, such as by refusing to warrant products sold outside of their authorized distribution network.

II. How are Warranties Managed for Gray Market Products?

The question of whether gray market goods must be warranted to the same extent as “legitimate” goods has not been directly addressed by the courts. However, cases addressing related issues suggest that manufacturers can refuse to warrant gray market products.

Product warranty issues are often litigated in the context of Lanham Act trademark-infringement disputes. Section 1114(a) (1) of the Lanham Act prohibits using any “reproduction, counterfeit, copy, or colorable imitation” of a registered mark in commerce when such use is likely to cause confusion, mistake, or deception. 15 U.S.C. §1114. However, the resale of a purchased product by its lawful owner does not infringe on the manufacturer’s trademark, since the sale is unlikely to result in confusion regarding the product’s origins. 17 U.S.C. §109; See Sebastian Int’l, Inc. v. Consumer Contacts (PTY) Ltd., 847 F.2d 1093 (3d. Cir. 1988).

There have been cases where manufacturers or authorized retailers, in attempting to prevent the unauthorized importation of products, have claimed that gray market imports are “materially different” products whose sale infringes on their trademarks rights, because the products are not warranted to the same extent as products sold by authorized distributors. These claims (often successful in trademark cases) highlight that courts have at least recognized that there can be a difference in the way manufacturer’s handle warranties for “legitimate” verses “gray market” products

In Swatch S.A. v. New City, Inc., the plaintiff, an exclusive U.S. distributor of Swatch products (watches, watch parts, jewelry and electronics), claimed that the defendant, an unauthorized retailer selling gray market Swatch products, infringed on the plaintiff’s intellectual property rights. 454 F.Supp.2d 1245, 1248 (S.D. Fla. 2006). Specifically, plaintiff alleged that the watches sold by the unauthorized retailer were “materially different” because “the warranties on watches sold by Defendant were “void.” The court, in holding that the difference in warranty constituted a material difference, stated: “By its own unambiguous terms, the [swatch] warranty is of no effect if the warranty card is not endorsed by an authorized dealer. The goods sold by Defendant, an unauthorized dealer, therefore, cannot qualify for coverage under the warranty.” Id. at 1251.

In fact, the case law is peppered with examples where manufacturers assert that warranties for the same product sold through different channels (legitimate verses gray-market sales) is evidence of trademark or copyright infringement. See e.g., Yamaha Corp. of America v. U.S., 961 F.2d 245 (DC. Cir. 1992) (“According to Yamaha-America, the gray-market products have the following physical differences: . . . they are not covered by the same warranties.”). Further, courts—aware of the different warranties being offered—have not question the legality of the practice, but rather highlight the practice as evidence of trademark infringement. See, Kia Motors America, Inc. v. Autoworks Distrib., 2009 U.S. Dist. LEXIS 15642, *12-13 (D. Minn. Feb. 26, 2009) (“The Court concludes that KMA has met its burden of establishing that there is a material difference between KMA's parts and Defendants' parts, namely the material difference is that Defendants' parts lack KMA's warranty.”).

The conclusion reached from the case law precedent is that manufactures can and do distinguish between products sold through authorized dealers with warranties and those sold through gray market channels. The courts have not limited this distinction.

Bottom Line: A manufacturer is not required to warrant gray market products and can differentiate its warranty or provide no warranty for gray market products.

III. What about the Federal Magnuson-Moss Warranty Act – Can a manufacturer limit a warranty only to persons who have purchased product through an authorized dealer?

The Magnuson-Moss Warranty Act (MMWA) establishes requirements for written warranties for consumer goods. 15 U.S.C. 2301 et. seq. The MMWA does not specifically address whether a company can limit warranties only to products purchased from authorized dealers. The Federal Trade Commission’s interpretation of the MMWA suggests that limiting warranty coverage to certain persons—including, presumably, those who do not purchase their product through an authorized retailer—is acceptable.

Under the MMWA, a manufacturer that provides a written warranty for a consumer product must clearly and conspicuously disclose in a single document in simple and readily understood language, the following information: The identity of the party or parties to whom the written warranty is extended, if the enforceability of the written warranty is limited to the original consumer purchaser or is otherwise limited to persons other than every consumer owner during the term of the warranty. FTC Consumer Practices, 16 C.F.R. § 701.3 (2007) (emphasis added).

The language of § 701.3 implies that a manufacturer can specify limitations on the persons to whom a warranty extends and such limitation could include gray market purchasers. Given that the relevant case law discussed above supports such an interpretation, a reasoned analysis concludes that § 701.3 permits a manufacturer to refuse to warrant gray market products, as long as such limitation is clearly disclosed pursuant to the other requirements of the MMWA.

IV. Are there best practices for disclosing to consumers a gray market warranty policy?

There is no single strategy for managing gray-market warranty claims. Most companies do not have a specific policy, but manage the issue on a case-by-case basis. Companies should consider a consistent strategy based on important business factors, such as:

a. quality of the product b. number of warranty claims expected c. cost of performing warranty service d. size of the gray market problem e. relationship with authorized retailers f. frequency or repeat sales to same customer base g. specific industry or market place drivers h. potential for harm to brand reputation by refusing to warrant.

Where a manufacturer decides not to warrant gray market products, consideration should be given to restatement of this policy on the company’s warrant documentation. It would be prudent to also inform authorized dealers so that they do not accept warranty claims on gray market products. The balance here is that a gray market warranty policy may save money on warranty service, but it may also damage the brand and reputation of the manufacturer (e.g., if the retailer opts to push sales to products that provide a more fulsome warranties because it increases income for sales and warranty claims). This is a business decision that must be answered in order to determine the ultimate warranty policy.

V. Are there strategies to limit warranty claims for gray market products?

The most obvious, but perhaps the most difficult strategy for reducing gray market warranty claims is to reduce the gray market. It is often difficult to keep tight control over the authorized distribution network—but consider developing strong relationships with authorized retailers and using serial numbers or other means to track products to the market.

As noted above, a manufacturer could also inform customers, both pre- and post purchase, that gray market products will not be warranted. This might be accomplished through provision of a limited written warranty, providing warranty coverage only to the original purchaser, adopting a warranty registration process and disclosing warranty terms through product literature, authorized dealers, and company internet sites. If a customer decides to forego products with warranty coverage in favor of a less expensive gray market products, the company will have in place a warranty policy that clearly articulates who is eligible for warranty coverage.

There is no single model or best practices that have been deployed to respond the explosion in sales of gray market products. What might be a good strategy for one company could be completely opposite for another company. As a practical example, the warranty on a national branded camera states “[we] will service products purchased only through an authorized retailer [and] declines gray-market repairs even if a customer is willing to pay for them.” See, Some see red over gray-market goods, USA TODAY, Dec. 11, 2006, http://www.usatoday.com/tech/products/2006-12-10-gray-market_x.htm. On the other hand, Apple Computer’s Limited Warranty covers all “hardware products manufactured by or for Apple that can be identified by the “Apple” trademark, trade name, or logo affixed to them.” This warranty covers all gray market products, as long as the serial number has not been removed or defaced. Apple Hardware Warranty, http://images.apple.com/legal/warranty /docs/cpuwarranty.pdf.

Listed below are some other exemplar manufacturers, and the extent to which they warrant their gray-market products:

Nintendo: Provides the same warranty to gray market and legitimate hardware, provided the owner can prove the date the product was purchased, and provided the serial number has not been altered, defaced, or removed. Nintendo, U.S. & Canada Warranty, http://www.nintendo.com/consumer/manuals/warrantytext_eng.jsp.

Sony Ericsson: Reserves the right to refuse warranty service unless a customer provides proof of purchase from an authorized dealer specifying the date of purchase and serial number. Sony Ericsson, Limited Warranty,http://www.sonyericsson.com/cws/download/1/835/2/1192957031/ LimitedWarranty_R1c_EN.pdf.

Ticino Watch Company: Provides warranty coverage only for products purchased through an authorized dealer and accompanied by a warranty certificate stamped and signed by the authorized dealer showing the date of purchase and model number. Ticino Watch Co., TICINO U.S.A., L.L.C. Warranty Service, http://www.ticinowatches.com/service.html.

Conclusion

A manufacturer can limit or refuse to provide a warranty for gray market products. However, companies must carefully consider the business risks of such a warranty policy. If a consumer buys a gray market product, and it fails to perform as expected, there may be damage to the brand and reputation of the manufacturer. The manufacturer may want to stand behind its product through warranty to protect the significant resources it has invested in branding and reputation. It may also want to provide warranty coverage so that warranty service and the service parts meet the manufacturer’s high quality standards.

Even with the above considerations, the manufacturer may want to limit warranty costs and support its dealer network by promoting its warranty service for sales through authorized channels. If the manufacturer decides to exclude warranties for gray market products, there should be a clear articulation of this policy in the written limited product warranty. There should also be consideration of pre-sale information on the manufacturer’s product web site and in product literature to inform customers of the company’s warranty policy. This may reduce warranty claims and help mitigate the number of disgruntled consumers.

Congress Considers Ban on Cadmium, Barium and Antimony in Kids' Jewelry

Under CPSIA, the use of lead in children's products is highly regulated and restricted. A recent study commissioned by Associated Press demonstrates that some manufacturers are now using cadmium in lieu of lead in children's jewelry. Two bills working their way through Congress aim to stop this by banning the use of toxic heavy metals, including cadmium, in children's jewelry.

heavy metalsStudy reveals inexpensive children's jewelry often has cadmium content

Last fall, the Associated Press commissioned Dr. Jeff Weidenhamer of Ashland University to conduct lab testing of children's jewelry. Dr. Weidenhamer and his team tested 103 pieces of inexpensive children's jewelry purchased in Ohio, Texas, California and New York and found high levels of cadmium in the jewelry.

As Dr. Weidenhamer explains:

"The items were screened for the presence of high levels of cadmium using a technique called X-ray fluorescence. A total of 14 items contained more than 10% cadmium based on these tests. Additional testing was done on several of the high-cadmium jewelry items to determine the amounts of cadmium that might leach from the items if swallowed, and to determine the total cadmium content of items based on digestion of the metal in acid.

The maximum cadmium content found was 91.0%, or 910,000, in a Rudolph the red-nosed reindeer charm purchase at a dollar store in New York by Judy Braiman of the Empire State Consumer Group of Rochester, NY. Charms on another bracelet contained 89 and 91% cadmium, and a necklace pendant contained 79% cadmium. All of these pieces released dangerously high amounts of cadmium in leaching tests.

Cadmium is a toxic metal that is classified as a probable human carcinogen by the US Environmental Protection Agency. The primary hazard of chronic cadmium exposure is kidney damage, however recent research also links cadmium exposure to learning disabilities and loss of IQ in young children. The World Health Organization estimates the tolerable weekly intake for cadmium to be 7 micrograms per kg body weight per week. There are currently no standards for the cadmium content of jewelry items intended for children." For additional detail regarding the study, see the full Associated Press story in the Cleveland Plain Dealer.

Senator Schumer explained in a January 13, 2010 statement:

“This new report shows that cadmium is not only extremely harmful to our children but also extremely common in children’s products across the United States. There is enough evidence about how dangerous this metal is that we must take action immediately so no more children are put in harm’s way. It’s time to get this toxic metal—and all others like it—out of children’s jewelry and keep it out.”

On January 29, 2010, Walmart announced a voluntary recall of two necklaces with high levels of cadmium. Because sale of children's jewelry containing cadmium is not currently prohibited, the recall was voluntary. A safe alternative to lead that is currently being used by many manufacturers is zinc.

S. 2976 - Safe Kids' Jewelry Act and H.R. 4428 Children's Toxic Metals Act

On January 13, 2010, Representative Speier introduced H.R. 4428, the Children's Toxic Metals Act, and on Febraury 2, 2010, Senator Schumer introduced S. 2975, the Safe Kids' Jewelry Act.

The identical bills prohibit the manufacture, sale or distribution of children's jewelry containing cadmium (Cd), barium (Ba), and antimony (Sb). If a piece of children's jewelry contains any of these chemicals, then the jewelry will be deemed a banned hazardous substance under the Federal Hazardous Substances Act and persons who manufacture, sell or distribute the jewelry could be subject to criminal and civil penalties. The bills do not apply to “selling activity that is intermittent.”

Under the bills, "children's jewelry" is defined to include charms, bracelets, pendants, necklaces, earrings, or rings that are “designed or intended to be worn or used by children 12 years of age or younger and is sold or distributed at retail.” The test for determining whether the piece of jewelry is for children ages 12 and under parallels the test under the CPSIA and considers statements by the manufacturer, product labels, product advertising and packaging, customer perception and age guidelines adopted by the Consumer Product Safety Commission (CPSC).

The bills also require the CPSC to make annual reports to Congress on their efforts to enforce the law. Further, CPSC must study whether any other heavy metals should likewise be banned from children's products.

As written, the bills would take effect 90 days after their passage.

Toyota Faces Class Action Lawsuits

There has been a great deal of attention about Toyota’s recent recalls. Toyota’s sales fell 16% in January alone and Toyota’s executives have apologized and appeared before Congress. Toyota has recalled 8.5 million vehicles for ill-fitting floor mats, sticking gas pedals and braking flaws. Toyota has been accused of not issuing the recalls soon enough and, in addition to these troubles, the company now faces numerous individual and class action lawsuits throughout the United States.

Personal Injury. Lawsuits in both state and federal courts include personal injury lawsuits stemming from allegations of sudden acceleration problems in various Toyota vehicles. The personal injury suits include claims of fraud, breach of warranty, misrepresentation, unjust enrichment, deceptive trade practices and even serious injury and wrongful death. Some lawsuits seek punitive damages claiming Toyota’s original explanation that floor mats were to blame led to a delay in the recall.
Toyota Prius

Economic Damage. In addition to the personal injury suits, MSNBC reports over 40 economic consumer class action suits have already commenced in 30 states. These suits focus on the economic damages resulting from the car defects, including decreased resale value. In Florida alone, at least three class actions have already been filed and more are expected. One suit focuses on the difference in market value due to the defect and alleges $1 billion in damages, both compensatory and punitive, for violations of state consumer protection laws, breach of express and implied warranty, and unjust enrichment. Heidenreich v. Toyota Motor North America Inc., N.D. Fla., No. 4:10-CV-00035-RH-WCS, filed 2/1/10.

Suits have been filed in Colorado, Texas, Florida, California, Ohio and many other states. There is a chance all the federal class actions will be consolidated. A hearing before a panel of judges is set for March 25 in the U.S. District Court in San Diego.

Toyota Asks for Dismissal. Toyota maintains the sudden acceleration issues were not caused by an electronic defect and the company has sent repair kits to dealers with metal replacement plates for pedals. Toyota has asked one court to dismiss the first of the many class action cases. In Seong Bae Choi v. Toyota Motor Corp., Toyota requested dismissal stating the four plaintiffs suffered no “legally cognizable injuries in connection with the alleged defects.” Toyota also claims dismissal is warranted because property damage from unintended acceleration is not representative of millions of Toyota owners, there were no allegations Toyota failed to honor its warranty or make repairs, and one of the plaintiffs did not even claim she experienced the sudden acceleration.

Attorneys Toyota Action Consortium. About 25 consumer law firms in over 20 states have joined together in the “Attorneys Toyota Action Consortium” to file lawsuits against Toyota. Dr. Tim Howard, a law professor at Northwestern, is coordinating the effort. Howard also coordinated a tobacco lawsuit in Florida that led to a $20 billion settlement with the state of Florida and a $250 billion national settlement. Howard has stated: “This is the strongest and largest case for economic damages to American consumers we’ve ever had. … Major used-car valuation services like Edmonds, NADA, and Kelley Blue Book have already downgraded resale value by as much as 3.5%, and consumers can expect an additional decrease up to 6%. As a result, Toyota owners have been robbed of their investment, along with their ability to trade in these vehicles rather than submit to hasty and questionable repairs. In the meantime, they have also lost the use of their car. That’s economic damage, plain and simple.”

On Feb. 22, Toyota announced it had received a federal grand jury subpoena investigating the sudden acceleration problem in vehicles. It has been estimated the lawsuits could cost Toyota over $2 billion.

Valerie Paula is an Associate in the Regulatory Affairs Department at Dorsey & Whitney, LLC. Please see our web site at www.dorsey.com.