Trademark Counterfeiting: A New Danger that Lurks for Holdover Franchisees

Vol. 15 No. 4

By

Kilpatrick Townsend & Stockton LLP

Trademark counterfeiting may be the most nefarious species of trademark infringement. It frequently conjures up images of shady characters selling “fake” Rolex watches or Louis Vuitton handbags from dark street corners or organized crime selling tens of thousands of units of “bootleg” Microsoft computer software or Disney DVDs. One of the reasons trademark counterfeiting has posed such a serious problem for trademark owners is that it has been notoriously difficult to pursue effectively as individual sellers of counterfeit merchandise often refuse to disclose their sources and fail to maintain accurate records of their activities. As a result, Congress in 1984 passed legislation amending the Lanham Trademark Act specifically to address counterfeiting, including enacting a number of enhanced remedies designed to provide a strong financial disincentive to those involved in the sale of such merchandise.

What possible connection could this pose to the field of franchising? Although the issue is far from decided, more and more courts are holding that a holdover franchisee’s use of a franchisor’s federally registered trademark after termination of a franchise agreement constitutes trademark counterfeiting. A finding of trademark counterfeiting has wide-reaching consequences to holdover franchisees, not the least of which is that it exposes them to very serious monetary remedies. In ordinary trademark infringement cases pursued under the Lanham Act, the trademark owner is entitled to recover the defendant’s profits, any damages sustained by the trademark owner and the costs of the action. See 15 U.S.C. § 1117(a). In the event the infringement is particularly egregious, courts have the discretion to enter judgment in increased amounts of such profits or damages not exceeding three times such amounts. Id. However, the award of such increased amounts is typically reserved for the most egregious cases of infringement. The same holds true for attorneys’ fees, which may only be awarded in “exceptional cases.” Id. In contrast, where trademark counterfeiting is found, courts are mandated to award (i) “absent extenuating circumstances” three times the infringer’s profits or the trademark owner’s damages, whichever amount is greater, or (ii) at the election of the trademark owner, statutory damages of up to $1,000,000 per infringement, together with reasonable attorneys’ fees. Accordingly, whereas such extraordinary remedies are rarely awarded in cases of ordinary trademark infringement, they are routinely granted in cases of counterfeiting.

The key questions to be answered, therefore, are what is trademark counterfeiting and can a holdover franchisee’s use of a franchisor’s mark after termination of the franchise agreement be properly characterized as trademark counterfeiting? In order to prove a case of trademark counterfeiting, the trademark owner must establish four elements beyond ordinary infringement:

  • the defendant’s mark must be “counterfeit,” meaning “a spurious mark that is identical with, or substantially indistinguishable from, a registered mark” of the trademark owner;
  • the trademark owner’s mark must be registered on the Principal Register of the United States Patent and Trademark Office in connection with identical goods or services for which the defendant uses the mark;
  • the defendant must not have been authorized by the trademark owner to use the mark at the time the goods or services were manufactured or produced; and
  • the defendant must have acted with knowledge and intent.

See 15 U.S.C. §§ 1116(d)(1) and 1117(b).

Although the Lanham Act’s trademark counterfeiting provisions have been in existence since 1984, there have been surprisingly few cases that have discussed counterfeiting in the context of a former licensee’s post-termination use of a licensor’s federally registered mark, whether or not franchising is involved. Those that have done so in the context of franchising have reached different conclusions. The first post-1984 case on this subject appears to be U.S. Structures, Inc. v. J.P. Structures, Inc., 130 F.3d 1185 (6th Cir. 1997). There, the franchisor sued its former franchisee for continuing to use the franchisor’s federally registered trademark in connection with the former franchisee’s deck-construction business. The district court granted summary judgment in favor of the franchisor holding that the former franchisee’s continued use of the franchisor’s trademark constituted trademark counterfeiting and awarded mandatory attorneys’ fees under 15 U.S.C. § 1117(b). The Sixth Circuit reversed and remanded the case on the attorneys’ fees award. The court began its analysis by quoting the Lanham Act’s definition of a counterfeit mark. But it then summarily concluded that a holdover franchisee’s use of the franchisor’s trademark post-termination is not the use of a counterfeit mark, despite finding that use was unauthorized. 130 F.3d at 1192.

Despite the Sixth Circuit’s seemingly definitive ruling in U.S. Structures, a number of other courts have reached the opposite conclusion. For example, in Choice Hotels International, Inc. v. Pennave Associates, 159 F. Supp. 2d 780 (E.D. Pa. 2001), aff’d, 43 F. App’x 517 (3d Cir. 2002), the district court examined an arguably analogous issue of whether a former franchisee’s use of a franchisor’s federally registered mark, which was never authorized in the first instance, constituted trademark counterfeiting. There the franchisee executed a franchise agreement with the franchisor to operate a hotel under the franchisor’s federally registered trademark that was expressly contingent on the franchisee’s making certain renovations to its premises. The franchisee never made the requested renovations, yet initiated use of the franchisor’s mark and refused to cease that use despite repeated requests to do so. After a trial on the issue of damages, the court found that the franchisee’s use of the franchisor’s mark constituted counterfeiting and that the franchisor was entitled to pursue an award of statutory damages under 15 U.S.C. § 1117(c).

Hospitality International, Inc. v. Mahtani, Civ. A. No. 2:97CV87, 1998 Westlaw 35296447 (M.D. N.C. Aug. 3, 1998), addressed the same issue as U.S. Structures albeit in the context of a default judgment. Hospitality and Mahtani entered into a franchise agreement that was terminated as a result of Mahtani failing to pay certain amounts to Hospitality including monthly franchise fees. Hospitality sued and included a count for trademark counterfeiting. The court found that Mahtani’s use of the franchisor’s federally registered mark after termination was the use of a counterfeit mark as defined by the Lanham Act. The court appeared to be unaware of the then recent contrary holding of U.S. Structures and relied instead on related precedent that had found the use of a registrant’s service mark by a licensee in connection with unauthorized goods to constitute use of a counterfeit mark. In view of that precedent, the court concluded that “the totally unauthorized use of a registrant’s service mark by a former licensee must be the use of a counterfeit mark.” 1998 WL 35296447, at *27. Further, because Mahtani did not plead any “’extenuating circumstances’”, the court held that it “must” award Hospitality treble profits and attorneys’ fees. Id. at *27, 30. Similarly, in Century 21 Real Estate, LLC v. Paramount Home Sales, Inc., 2007 WL 2403397 (E.D. N.Y. Aug. 20, 2007), the court also concluded in the context of a default that a former franchisee’s post-termination use of Century 21’s registered marks constituted counterfeiting and awarded treble damages under 15 U.S.C. § 1117(b).

Most recently, Century 21 Real Estate, LLC v. Destiny Real Estate Properties, 101 U.S.P.Q.2d (BNA) 1423 (N.D. Ind. 2011), considered whether a former franchisee’s post-termination use of the franchisor’s registered mark constituted trademark counterfeiting, again in the context of a default judgment. There the franchisor terminated the franchisee as a result of the franchisee’s repeated failure to make certain required payments due. After ascertaining that the former franchisee continued to operate under Century 21’s registered marks, including on signs outside its office and on various websites, Century 21 sued the former franchisee for, among other things, trademark counterfeiting. The former franchisee failed to defend the action and the franchisor then moved for entry of default judgment including an award of damages for trademark counterfeiting.

The court began its analysis by noting the split of authority on whether a holdover franchisee’s continued use of the franchisor’s marks after termination constituted counterfeiting and observed that the Seventh Circuit had not as yet expressly considered that issue. However, it found significant that the Seventh Circuit had earlier ruled in General Electric Co. v. Speicher, 877 F.2d 531 (7th Cir. 1989), that a finding of counterfeiting was not limited to cases where a trademark owner’s registered mark had literally been copied, but also included use of the genuine mark on unauthorized goods. In that case, General Electric sued Speicher for trademark infringement when it discovered that Speicher was supplying its own inserts for industrial cutting tools in genuine General Electric-labeled boxes. In reversing the district court’s holding that Speicher’s actions did not constitute counterfeiting, the Seventh Circuit reasoned that “the happenstance of having trademarks made by the owner in one’s possession, so that one doesn’t have to copy them had no relevance to the counterfeiting determination because in that instance the alleged ‘imitation’ was not merely colorable but perfect.” Id. at 535. The Century 21 court relied on this statement in holding that a former franchisee’s post-termination sale of nongenuine services “wrapped in the ‘package’ stamped with the former franchisor’s trademarks” constituted counterfeiting. Century 21 Real Estate, LLC, 101 U.S.P.Q.2d (BNA) at 1427.

What makes the decision in Century 21 even more interesting is that the court went further and addressed head on the contrary decision in U.S. Structures. In that regard, the Century 21 court concluded that the Sixth Circuit’s holding was not viable in light of Speicher. But even in the absence of Speicher, the court observed it would have found counterfeiting had occurred under U.S. Structures’ facts because it could conceive of no reason why an ex-franchisee should escape liability for counterfeiting simply because it had access to the franchisor’s genuine marks because of the former licensed relationship and, therefore, did not need to engage in the reproduction of an identical or substantially similar mark. Id. at 427-28.

Although the author does not expect that the Century 21 case will result in the floodgates being opened such that trademark counterfeiting will routinely be asserted in cases in which a holdover franchisee continues to use a franchisor’s federally registered mark post-termination, at least until the law becomes more settled, and more federal courts of appeal, and perhaps the U.S. Supreme Court, weigh in, it is undeniable that this theory is gaining momentum. In light of the dire consequences former franchisees face in having their post-termination trademark use of a franchisor’s federally registered mark held to constitute counterfeiting, they would do well to consider carefully this issue in developing and executing a plan for leaving the franchisor’s system.

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