Every producer of consumer products has some version of this story: You spend untold time, money, and effort perfecting your product and the end user’s experience for the simple reason that satisfied customers are repeat customers, and repeat customers recommend products to family and friends. You strive to control every aspect you can about getting the product from your factory to the customer’s hands, and even beyond that point, to make sure that the customer remains satisfied after purchase. You spend your days doing little else. The effort keeps you awake at night. Then you go online and find someone not affiliated with your company or one of your distributors selling your product at a deep discount. Without even knowing it, you’ve been plundered by the grey market pirates, and you want to know how to fight back. You are not without weapons in this fight, but it is critical that you act swiftly, proactively, deliberately, and strategically.
The practical necessity of using distribution channels unavoidably introduces the risk of losing control of your own product. In American law, there is a concept known as the “first sale doctrine” which holds that, once the producer sells the product for the first time under normal circumstances, the producer loses the ability to further control its distribution. This is true regardless of copyrights, trademarks, or patents. Once it’s sold into the stream of commerce, the next owner is free to do with that product as he or she pleases.
This is where the so-called “grey market” sellers — actors with no relationship to the producer who sell the producer’s products outside of authorized distribution channels — can effectively insert themselves into the chain of distribution and cannibalize sales, eat into your bottom line, and possibly harm brand reputation with inferior products or services. It is called the “grey market” because it exists in the twilight of legal ambiguity between normal fully legitimate transactions and illegal “black market” transactions.
Grey market sellers are all too willing to accept lower margins to trade on the good name others have worked so hard to build. They will often sell improperly sourced products, questionably obtained products, and even expired products, passing them off as the genuine article using the brand equity that you created. It doesn’t take much imagination to figure out how your products would end up in the hands of a grey market seller:
Example #1: Your authorized distributor decides it needs to offload a substantial amount of your product quickly, and so sells at the distributor’s wholesale price (or less) to a third party unauthorized grey market seller, who then resells your products through some other channel (i.e. Amazon, eBay) below MSRP.
Example #2: A retail store goes out of business while in possession of your products, and the grey market seller purchases your products well below wholesale price at an auction, allowing them to resell the products through another channel at a steep discount.
Example #3: The grey market seller purchases versions of your products intended for a foreign market from an authorized overseas distributor and attempts to resell them domestically.
Example #4: A pallet of your products “falls of the truck” and winds up in the hands of a grey market seller, which is then sold at a deep discount.
The list could go on ad infinitum.
While some grey market sellers exist in the brick-and-mortar world, such twilight economy players are especially prevalent on online marketplaces, such as Amazon and eBay. Many such sellers will, when confronted by a producer, claim protection under the first sale doctrine. Unfortunately, there are instances where the grey market seller is correct that their conduct is legal, and the raider may simply ignore demands that the activity cease, raise the first sale doctrine as a defense against claims asserted by the producer, or even proactively file suit against the producer asking the court to declare that the grey market sales activity is legal. Accordingly, you must plan ahead and be prepared when the fight comes to you.
The first sale doctrine is not absolute. It has at least two exceptions recognized in virtually every jurisdiction across the country: (1) the “material difference” exception; and (2) the “quality control” exception. The two concepts overlap in the sense that their application is rooted in customer confusion: if the customer believes they are getting genuine products that carry your brand — those that you’ve ensured the quality of and stand behind — but that is not the case, then the first sale doctrine may not apply.
The difference between the genuine product and the grey market product need not be large for the “material different” exception to apply. The difference can encompass many different things, such as warranties, money back guarantees, or post-purchase benefits and services, just to name a few. As some courts put it, if there is a “bundle of services” attached to a product sold through proper channels that is not available to the grey market customer, and the customer has no way of knowing that, then the first sale doctrine is much less likely to shield the grey market seller’s activities.
The “quality control” exception relies upon exactly what one would expect: the processes put in place by the producer to ensure the quality of the end product reaching the customer. If the grey market seller fails to follow the producer’s quality control processes, or even merely interferes with the producer’s ability to monitor quality of the product, the grey marketeer can lose the protection of the first sale doctrine.
With both exceptions, the key to defeating the first sale doctrine rests upon a few simple concepts:
- Preparation: You need to take the steps and put processes in place to defeat grey market sellers before you’re in a dispute. In considering what methods will best allow you to protect your products, your chosen methods cannot be pretextual or illusory — the method must confer some additional benefit on the customer they would not otherwise receive but obviously not at a cost which is prohibitive.
- Publication: Whatever method you’ve chosen to protect your product from grey market sellers, you need to make the public aware of it in some way (i.e., providing warranty information, etc.). It must be at least plausible that a customer knows about the benefits of authorized purchases of your product, and that the benefits could affect their decision on who to buy from.
- Application: When the potential conflict arises, you must be willing to engage with the grey market sellers and enforce your rights. This can include everything from informal demands and discussion between the producer and grey marketeer, attorney demand letters, and even lawsuits if merited. As in many areas of the law, a selectively enforced policy is many times worse than no policy at all.
Implementing the above involves numerous strategies and considerations not covered by this article, e.g., registering trademarks, copyrights, patents, etc., and the feasibility and costs of the quality steps. Unfortunately, any technique chosen to defeat the grey market and any dispute with a grey market seller will be fact-intensive and specific to the producer, and must be individually reviewed and tailored. However, by taking appropriate strategic steps for your business at the outset, you can be prepared to fend off next attack on your brand equity from grey market piracy. Contact the professionals at MTFN to discuss your options, how to get the benefits of your hard-earned reputation for quality, and how to keep your powder dry.
