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Selling the Main Street Fairness Act: A Viable Solution to the Internet Sales Tax Problem

Congrats to Michael J. Payne, CPA of Arizona State University Sandra Day O’Connor College of Law one of the winners of the 2011 Spring National Law Review Student Legal Writing Contest. Michael’s topic addresses the tremendous struggle in the regulation of sales tax collection on interstate internet purchases.

I. Introduction

States have long faced issues related to collecting sales and use tax when the seller lives in another state. Initially, disputed transactions involved purchases from mail-order catalogs and telephone orders, but with the advent and explosion of the World Wide Web, states now face a tremendous struggle in the regulation of sales tax collection on interstate internet purchases.

Today, fierce debates between internet retailers, states, and consumers regarding sales taxes on internet purchases are commonplace, yet the key issues remain unresolved. Retailers purport to be exempt from state sales tax requirements when they do not have a physical presence in the state in which their customers reside; states argue sales taxes are due regardless of physical presence; and consumers just want to find the best deal when making purchases, which often means they seek out ways to avoid paying sales taxes altogether.

As a result of fast-moving technological advances and slow-moving legislative actions, a substantial gap has developed in nearly every state between sales tax revenue due and collected. A study from the University of Tennessee estimated that between 2007 and 2012, states will sustain over $52 billion in losses from uncollected taxes on e-commerce sales.¹ In addition to enlarging state budget shortfalls, untaxed interstate sales create an unfair advantage to online sellers who are relieved from the onerous sales tax collection duties imposed on in-state and traditional brick-and-mortar sellers. Thus, online sellers can offer discounts on products purchased from out-of-state residents while still earning higher profits than their in-state competitors.

Two significant constitutional hurdles restrict state regulation of interstate sales taxation: the Commerce Clause and the Due Process Clause, with the former causing the majority of current problems. This article focuses primarily on resolving the Commerce Clause concerns and attempts to reconcile the interests of sellers, consumers, and states. It then proposes the adoption of a bill that was recently introduced in the House of Representatives: the Main Street Fairness Act.²

II. Background

A. The Mechanics of Internet Sales Taxation

A basic understanding of common Internet sales taxation is needed to grasp the ideas discussed in this article. As a general rule, purchasers of merchandise must pay a transaction tax to the state in which they reside, provided that state imposes a sales or use tax.³ When the retailer collects the tax on behalf of the consumer and remits it to the state, it is called a sales tax.When a retailer fails to collect a sales tax, the consumer is obligated to report her purchase to the state and pay an equivalent use tax. The process is simple when the seller is in the same state as the purchaser: the seller collects taxes on local sales and remits them to the state. The more complicated and increasingly more common scenario is when the seller operates from another state; this situation has been the topic of numerous cases, statutes, opinion columns, Internet blogs, and scholarly articles, including this one.

Although state taxation of internet sales is a modern issue, courts have long debated whether the Constitution’s Commerce Clause limits the ability of a state to apply its sales and use tax provisions to out-of-state retailers.⁴ This Part describes the most significant cases.

B. National Bellas Hess, Inc. v. Department of Revenue of Illinois

In 1967, the Supreme Court considered whether a state could require a mail order company to collect and remit sales taxes on sales to residents of that state when that company had no physical presence in the state. In National Bellas Hess v. Department of Revenue of Illinois,⁵ the taxpayer was a mail order company incorporated in Delaware with its principal place of business in Missouri. It was licensed to do business only in those states. The taxpayer maintained no office or warehouse in Illinois, had no employees, agents, or salespeople there, and conducted no significant advertising there. Moreover, all contacts the company had with the residents of the state were through the mail or a common carrier. Illinois attempted to require the taxpayer to collect and remit sales and use taxes from Illinois residents who purchased the company’s goods by mail order.

The Court held that the Commerce Clause requires “some definite link, some minimum connection, between a state and the person, property, or transaction it seeks to tax.” Mail order transactions alone do not create that minimum connection. The Court reasoned “[t]he very purpose of the Commerce Clause was to ensure a national economy free from . . . unjustifiable local entanglements. Under the Constitution, this is a domain where Congress alone has the power of regulation and control.”⁶

C. Quill Corp. v. North Dakota

Twenty-five years after National Bellas Hess, the Court affirmed in part its prior decision when it faced a similar set of facts in Quill Corp. v. North Dakota.⁷ In Quill, North Dakota attempted to require the taxpayer, a Delaware corporation with no significant tangible property or employees in North Dakota, to collect and remit use taxes from sales to North Dakota customers. The taxpayer solicited business through catalogs and flyers and delivered all its merchandise by mail or common carrier from out-of-state locations. The State argued that its statute subjecting every retailer that solicits business in the state to the tax was constitutional when the retailer had “engage[d] in regular or systematic solicitation of a consumer market in th[e] state.”

The Court disagreed, recognizing two constitutional barriers to a state’s ability to force out-of-state retailers to collect and remit sales taxes: the Due Process Clause and the Commerce Clause. The Court distinguished the Due Process Clause from the Commerce Clause, explaining:

Although the “two claims are closely related,” the Clauses pose distinct limits on the taxing powers of the States. Accordingly, while a State may, consistent with the Due Process Clause, have the authority to tax a particular taxpayer, imposition of the tax may nonetheless violate the Commerce Clause. The two constitutional requirements differ fundamentally, in several ways. . . . [W]hile Congress has plenary power to regulate commerce among the States and thus may authorize state actions that burden interstate commerce, it does not similarly have the power to authorize violations of the Due Process Clause.⁸

The Court concluded that because Quill had purposefully directed its activities at North Dakota, it established minimum contacts with the State, and thus the Due Process Clause did not prohibit the State from imposing its use tax against Quill.

The Court next considered whether the state statute ran afoul of the Commerce Clause. It recognized Congress’ constitutional authority to “regulate Commerce with foreign Nations, and among the several States,”⁹ but also recognized that the “dormant” Commerce Clause¹⁰ reserves to Congress the exclusive power to regulate interstate commerce even when it has not spoken directly on a subject. The dormant Commerce Clause requires that the retailer have a “substantial nexus” with the state before the state can force the retailer to collect and remit sales taxes, which often translates into a bright line physical presence test.

The Court held that North Dakota did not have the power to impose sales taxes on Quill because Quill had no physical presence in the state. It also found that the state’s taxation would unduly burden interstate commerce, noting that “similar obligations might be imposed by the nation’s 6,000-plus taxing jurisdictions,” thus vastly increasing the complexity of sales tax compliance for interstate retailers.

D. Streamlined Sales and Use Tax Agreement

In the shadow of the Quill decision, a new and far-reaching mode of commerce arose: the World Wide Web. Many retailers no longer needed to send catalogs to solicit sales. Instead, they could simply set up websites, make them apparent to search engines, and wait for customers to come to them. The following chart illustrates the historic growth of the Internet:

Year	Estimated Number of Websites	Estimated Percentage of U.S. Households with Internet Access	E-Commerce sales
1992 (Quill)	< 30	< 25%	n/a
2000 (SSUTA)	17,000,000	50%	$27.6 billion
2010	249,000,000	77%	$202.6 billion

The monumental growth in online sales has contributed to the two major problems currently associated with the taxation of remote sales: administrative burdens to sellers and lost revenues to states from general noncompliance. In 1999, state and local governments from twenty-six states responded to these by banding together and implementing a new sales tax system. The group’s goal was to create and implement a method to unify and simplify the collection and remittance of sales taxes across the country, an effort that culminated in the Streamlined Sales Tax Project.¹¹

The Project works through two steps. First, states voluntarily join the Streamlined Sales Tax Agreement by adopting its provisions as state law and conforming to the tax administration procedures set for by the Agreement. Second, interstate retailers voluntarily register with the Project’s online system. Sellers only register once and are thenceforth obligated to collect and remit sales taxes to member states when they sell products to residents of those states.

The Agreement reduces the administrative burden of tax compliance by focusing on two main goals: uniformity and simplification. The Agreement promotes uniformity in multistate sales tax collection at five levels: terminology, tax bases, registration, sourcing, and reporting. It simplifies sales tax collection and reporting by focusing on four areas: limited tax rates, seller liability for incorrectly reported exemptions, simplified tax forms, and electronic tax remittances. Additionally, it provides for sales tax software that, if used, would provide immunity to users from audits and corresponding liability.

A. Congressional Efforts to Regulate Internet Sales Taxes

Although states have been very active recently in attempting to regulate sales tax collection for out-of-state retailers, the power to regulate taxation of interstate commerce ultimately lies in Congress’s hands, as established by the Commerce Clause and reiterated in Quill. Since Quill, Congress has attempted several times to pass legislation that would provide federal authorization for states to mandate sales tax collection from out-of-state retailers, thus allowing states to bypass the substantial nexus requirement imposed by Quill.¹²However, each bill that has been proposed has expired without being voted on by the House or Senate.

B. Recent State Efforts to Bypass Quill’s Substantial Nexus Requirement

Dissatisfied with Congressional efforts (or lack thereof) to increase cooperation with sales tax laws, states have attempted in various ways to establish a substantial nexus between online retailers and their state and thereby satisfy the requirements of the Commerce Clause.

a. Borders Online v. State Board of Equalization

In 2005, the California Court of Appeals held in Borders Online v. State Board of Equalization that Borders’ retail stores in the state acted as authorized representatives of the associated online store when those stores accepted refunds of personal property sold by the internet retailer, thus establishing a nexus sufficient for the imposition of sales and use taxes under the Commerce Clause.¹³

After Borders, remote sellers in California sought clarification on whether their particular fact situations produced sufficient nexus to subject them to California state and local taxation. Courts look at various factors to determine the level of nexus,¹⁴ and consider these factors concurrently. An increasingly relevant factor that courts have examined is the presence of a company’s affiliates in a state, or “attributional nexus.” Courts have long looked at attributional nexus as a way to satisfy the Commerce Clause requirements, although the issue has never been directly addressed by the United States Supreme Court.

b. Amazon.com, LLC v. New York State Department of Taxation and Finance

Most recently, a New York trial court, later affirmed by the New York Appellate Division, weighed in on attributional nexus in Amazon.com, LLC v. New York State Department of Taxation and Finance.¹⁵ In 2008, New York attempted to curtail lost revenues from internet sales by amending the definition of “vendor” in its tax law, thus requiring each of Amazon’s Associates to collect sales taxes. Amazon then brought suit claiming that the Provision violated the Commerce Clause by imposing tax collection obligations on out-of-state entities that had no substantial nexus with the state. The court dismissed Amazon’s complaint for failure to state a cause of action, holding that the statute is not unconstitutional facially or as-applied. The court took a broad view of the substantial nexus requirement when it held that Amazon had created a substantial nexus with the State, even though Amazon had no offices, property, employees, or agents in the state. The court noted that physical presence “need not be substantial;” however, there must be “more than a slight presence.”

SinceAmazon, many New York retailers have terminated associations with in-state retailers and local affiliates to avoid being subject to sales tax collection. One website purports to list sellers that have removed New York affiliates after the passage of New York’s legislation, naming almost sixty remote sellers.¹⁶ The list includes some large companies such as Overstock, KB Toys, ShopNBC, CafePress, and Fingerhut. As a result, the statute may have actually hurt local retailers, the very group it was trying to protect by leveling the sales tax playing field.

c. The Bordersand AmazonFallout

The Amazon ruling has influenced other states to pass similar legislation in attempts to collect their own “Amazon tax.” For instance, in 2009, Rhode Island passed a statute that requires online merchants generating more than $5,000 in sales through in-state affiliates to register and collect sales tax on all its taxable sales in Rhode Island.¹⁷ Like the New York law, Rhode Island’s statute requires that the seller enter an agreement with a Rhode Island resident before the seller would be subject to sales tax collection.

Following the lead of New York and Rhode Island, North Carolina passed a statute¹⁸ enacting its own Amazon tax with a $10,000 floor, explaining that the new law codifies the United States Supreme Court’s 1960 decision in Scripto v. Carson that a state “may require tax collection by a remote retailer that had contracts with ten independent contractors in the state who solicited orders for products on its own behalf.”¹⁹ North Carolina simultaneously modernized its previous terminology by replacing “mail order” with “remote sales.”²⁰ Similar statutes were introduced in eleven other states.²¹

Colorado took its sales tax collection efforts a step further. In addition to enacting its own “Amazon tax,” Colorado’s H.B. 1193 (2010) would require sellers that do not collect sales taxes to send customers that purchase products online annual statements listing total purchases.²² Retailers would also send a copy of all purchases to Colorado’s Department of Revenue so that residents may be held accountable for unpaid use taxes.²³ The bill would authorize Colorado’s Executive Director of the Department of Revenue to issue a subpoena to an out-of-state retailer if that retailer refuses to voluntarily furnish that information. However, this statute is the subject of a recent lawsuit brought by the Direct Marketing Association. A federal court for the District of Colorado recently granted DMA’s motion for preliminary injunction against Colorado, holding that its statute “discriminates patently against interstate commerce” and imposes undue burdens on retailers.²⁴

Oklahoma took a different approach to regulating sales tax collection from out-of-state sellers.²⁵The Oklahoma law obligates certain remote sellers to post on their websites, catalogs, and invoices notice of consumers’ obligations to pay Oklahoma use tax on electronic and mail order purchases of tangible personal property.²⁶ Oklahoma’s law has been criticized as superfluous in application to internet and mail order sellers that have physical presence in the State because current Oklahoma use tax statutes already impose the obligation on those sellers to collect use taxes. Furthermore, the law is criticized as unconstitutional when applied to out-of-state sellers that have no physical presence in the State, because Quill’s interpretation of the Commerce Clause would prohibit Oklahoma from enforcing tax collection responsibilities on a seller with no physical presence in the state.

d. The Case for a Federal Solution

A uniform federal solution is superior to progressive state-by-state attempts to collect sales and use taxes for three reasons. First, states are tiptoeing on the edge of a river of constitutionally-protected consumer privacy matters. Second, strict enforcement of use tax laws at an individual level is hardly tenable given the historic lack of enforcement and the resulting lack of personal accountability. The proposed solutions impose real burdens on people and will discourage online purchases. Can you recall everything you have purchased online in the last year? In the last five years? You may have to if you are in a progressive sales tax collection state. It is much simpler and more intuitive for consumers to pay the tax up front as one swift transaction than to log their purchases, store the information, and file a use tax return with their payment at some later date. The increased hassles of recording each purchase could drive people back into brick-and-mortar stores, nullifying the efforts of Amazon and other remote sellers. For this reason, remote sellers should embrace the Main Street Fairness Act as a means to create certainty and consistency in the marketplace.

Finally, the trending methods of sales and use tax enforcement are completely inefficient. This is a situation in which it makes sense to take collective federal action rather than pursue state collection efforts at the individual taxpayer level. States would be forced to allocate substantial resources toward collection efforts while receiving no greater benefit than if the tax had been collected at the time of sale. With the Main Street Fairness Act, states would incur virtually no additional costs of expansion and would continue to use their existing collection methods. States are already entitled to collect these taxes whether in the form of sales or use taxes; why not utilize retailers with software and systems already in place?

The Center on Budget and Policy Priorities has argued that states’ implementation of the “Amazon law” could be an effective means to require sales tax collection from internet sellers that use affiliate programs.²⁷ However, the Center observed, Amazon laws are only a partial solution to the broader sales tax problem. Not every internet retailer operates an affiliate program, so the Amazon law does nothing to spur collection efforts from the numerous vendors who advertise by other means. The Center concluded that a comprehensive solution will require a federal law empowering states and localities that have streamlined their sales tax collection efforts to require all large remote sellers to collect sales taxes. This would allow states to force collection on remote sellers regardless of whether the sellers have a physical presence in their customers’ states. Such a federal grant of commerce power is the precise objective of the Main Street Fairness Act of 2010.

III. Main Street Fairness Act

The Main Street Fairness Act, sponsored by former Representative Bill Delahunt (D-MA), seeks to “promote simplification and fairness in the administration and collection of sales and use taxes.”²⁸ It would do so by allowing states to force “remote sellers” (companies that sell products online, by mail order catalogs, cable TV shopping, telephone, etc.) to collect sales and use taxes from customers and remit them to states. States acting alone do not have the authority to require a seller with no physical presence in the state to collect taxes on sales to that state’s residents. However, Congress affirmatively possesses the authority to regulate commerce under the Commerce Clause of the Constitution of the United States and Congress may authorize state actions that burden interstate commerce. The Main Street Fairness Act would grant states explicit authority to burden interstate commerce by allowing states to mandate collection and remittance of taxes on remote sales to their residents.

Why should Congress give the Main Street Fairness Act a second glance when a form of the current bill has essentially been rejected every other year for the last seven years? This section will focus on three ways the Main Street Fairness Act would benefit interstate commerce: (1) it would provide states a tool to enforce active yet frequently disobeyed laws regarding sales and use tax reporting and payment; (2) it would level the playing field between Main Street and “e-street;” and (3) it would help to close the enormous budget gap that is growing daily as a result of the disparity between taxes due and taxes actually collected.

A. Enforce Current Laws

The Main Street Fairness Act would grant federal authority to states, thus allowing states to enforce sales and use tax laws that are currently in place but are often not obeyed. Sales or use taxes are legally due on internet sales if the item is otherwise taxable under state law. Generally, retailers collect taxes from customers on behalf of states for convenience. However, when a customer purchases a taxable item and the retailer fails to collect a sales tax, that customer is obligated to pay a use tax and file a use tax return with the state.

People often do not pay use taxes on internet purchases for two reasons. First and most commonly, the average consumer is unaware that a tax is due when she purchases a product from an online retailer such as Amazon or Overstock. In other cases, the consumer may be aware that a tax is due but fails to pay sales or use taxes because he believes the law is not enforced and he will not be caught. This is the more dangerous scenario because in knowingly failing to pay a tax that is legally due, the consumer crosses the line of intentional disregard and is more likely to violate that law again.

In an effort to both inform residents of their obligation to pay use taxes and to actually collect those taxes, many states have started to include a line on their income tax returns where taxpayers are supposed to calculate and declare unpaid taxes. For example, Michigan includes the following line on its individual income tax return: “Use Tax: Use tax due on internet, mail order or other out-of-state purchases,” then references a separate worksheet that is provided to help the taxpayer calculate use tax due.²⁹

Some states have begun to enforce use tax compliance on an individual level, sending tax bills to consumers that had made taxable purchases but failed to pay a tax. Nebraska recently cracked down on a local March of Dimes chapter after the chapter purchased 4,000 t-shirts from an online vendor in Florida. Nebraska tracked purchases for the preceding five years and could collect an estimated $215,000 from the charity, or approximately thirteen percent of the donations. Other states are less stringent, allowing a de minimis exemption for individuals.³⁰

Some states have attempted to enforce sales and use tax compliance by leveraging customers to act as whistleblowers when companies knowingly fail to collect those taxes.³¹ Under these false claim statutes, individual consumers may bring suits on behalf of the state against parties that knowingly violated sales tax laws. If successful, the whistleblower would be entitled to a portion of the state taxes collected.

While states have had some success tackling the noncompliance issue on their own through enacting Amazon laws or similar statutes, the federal government is the sole body that is constitutionally charged with regulating interstate commerce and therefore should provide states with a tool to help them enforce their laws and uniformly tax interstate commerce. If passed, the Main Street Fairness Act could effectively serve as that tool.

B. Level the Playing Field

Perhaps the strongest policy reason for implementing a federal law to delegate Commerce power to states is the inherent unfairness that results from forcing some companies to charge their customers sales taxes while others do not have to charge any sales tax.

Two groups are hurt by current disparities in sales tax enforcement: local retailers and large companies with physical presence in many states. Small local retailers (mom and pop shops) are at a distinct disadvantage when their online competitors do not have to charge customers sales tax. Recent studies indicate that many consumers are beginning to follow a “just looking” trend whereby they test products in local stores by seeing, touching, and feeling them, then rush home to order the same products online where they can avoid paying sales taxes.³² According to one consumer behavior report, seventy-five percent of online consumers sought to purchase from merchants that did not charge sales tax and offered free shipping.³³ The savings are even greater when buying in bulk, thus enticing large organizations to shift their purchasing patterns away from small local retailers to reduce costs in a bad economy.

Ironically, opponents of internet sales tax regulation argue that enforcing sales tax laws would do greater harm than good to small retailers.³⁴Such opponents reason that the last decade has provided an unprecedented opportunity for individuals to start small companies that leverage the Internet to grow quickly, thus spurring the economy and creating jobs.Less than one month after the Main Street Fairness Act was introduced, a group of U.S. Representatives introduced the “Supporting the Preservation of Internet Entrepreneurs and Small Businesses” resolution.³⁵ The Preservation bill focuses on avoiding “any legislation that would grant State governments the authority to impose any new burdensome or unfair tax collecting requirements on small online businesses and entrepreneurs.” Representative Dan Lungren, sponsor of the Preservation bill, commented:

The most effective thing we can do to help our economy recover is to remove the roadblocks standing in the way of our nation’s job creators. At a time when we are trying to foster a sustained economic recovery, it doesn’t make sense to saddle entrepreneurs with tax requirements that stifle growth. The possibility of new taxes being levied on online retailers will have a negative impact on the online marketplace. We should send a clear message that Congress should not burden small businesses with unfair tax schemes.

The Preservation bill is constructed on two false premises. First, it presupposes that federal legislation granting states Congressional authority to collect sales taxes would impose a new tax. As discussed in the previous section of this article, sales and use taxes are already due in nearly every state on online purchases. A federal grant of authority would therefore not impose a new tax, but loosen the handcuffs Quill placed on states to enforce their own laws. Second, the Preservation bill is aimed at protecting small businesses and entrepreneurs. While noble in its purpose, the Preservation bill is simply unnecessary; the Main Street Fairness Act’s small seller exception would exempt from sales tax collection the very businesses the Preservation bill aspires to protect.

Another group that is damaged by the current system is large online retailers that have a physical presence in many states, such as Wal-Mart or Target. Most, if not all, online sales from these stores are subject to sales taxes because they have a physical presence in nearly every state. These companies put appropriate resources into ensuring that the taxes are properly collected and remitted. The inconsistency arises when comparing a company like Wal-Mart to a company like Amazon. Both are large companies that sell products to residents in every U.S. state and territory. However, Wal-Mart has stores in every state, while Amazon only has physical presence in a handful of states, thus creating a real disparity that needs to be addressed.

C. Bridge the Budget Gap

It is no secret that states are struggling to find revenue sources while tax collections are down nationwide. Advocates of internet sales taxation correctly promote the Main Street Fairness Act as a way for states to raise revenue without imposing additional taxes. While allowing states to enforce sales tax collection on all of its residents’ purchases would not solve the current budget crisis, it would allow states to take a healthy step in the right direction.

IV, Conclusion

Regardless of which political party is in the majority, the Main Street Fairness Act should be given consideration as a viable solution to the problems discussed above. Its passage would comport with the constitutional grant of authority over interstate commerce to Congress, while allowing states the freedom to choose whether to voluntarily join the Agreement. This system is ideal because states can preserve their independence by joining or leaving the Agreement at any time, while providing substantial benefits to out-of-state retailers by simplifying and unifying their reporting requirements. The Main Street Fairness Act is the bandwagon heading toward uniformity and fairness in sales tax collection. States just need to jump on.

[1] Donald Bruce, William F. Fox & LeAnn Luna, State and Local Government Sales Tax Revenue Losses from Electronic Commerce, U. Tenn. Center Bus. Econ. Res., Apr. 13, 2009, available at http://cber.utk.edu/ecomm/ecom0409.pdf.

[2] Main Street Fairness Act, H.R. 5660, 111^th Cong. (2010).

[3] Five states do not currently impose a sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. Richard Stim, Sales Tax on the Internet, http://www.nolo.com/legal-encyclopedia/sales-tax-internet-29919.html.

[4] See, e.g., Quill Corp. v. North Dakota, 504 U.S. 298 (1992), National Bella Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), Scripto, Inc. v. Carson, 362 U.S. 207 (1960).

[5] National Bella Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967) at 756.

[6] National Bella Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967) at 758–60. (internal citations omitted).

[7] Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

[8] Quill at 305 (internal citations omitted).

[9] U.S. Const. art I, § 8, cl. 3.

[10] The dormant Commerce Clause is a judicially-created doctrine that “rests entirely on the negative implications of the Commerce Clause of Art. I, § 8, cl. 3.” See Kathleen M. Sullivan, Gerald Gunther, Constitutional Law 174 (Thomson West 2007).

[11] Streamlined Sales Tax Governing Board, Registration Frequently Asked Questions, [hereinafter FAQs], http://www.streamlinedsalestax.org/index.php?page=faq. …

[12] Streamlined Sales and Use Tax Act, S. 1736, H.R. 3184, 108^th Cong. (2003); Sales Tax Fairness and Simplification Act, S. 2152, 109^th Cong. (2005); Streamlined Sales Tax Simplification Act, S. 2153, 109^th Cong. (2005); Sales Tax Fairness and Simplification Act, S. 34, H.R. 3396, 110^th Cong. (2007).

[13] Borders Online v. State Board of Equalization, 129 Cal.App.4th 1179, 1189–92 (Cal. App. 2005).

[14] Id. at 664–666, (listing some of the factors courts have examined in searching for substantial nexus: business ownership structure, common logos and names, common merchandise, use of private or branded credit cards, links between affiliates’ websites, credit card reward programs, gift certificates and gift cards, trademarks, goodwill, and return policies).

[15] Amazon.com, LLC v. N.Y. State Dep’t of Tax’n & Fin., 877 N.Y.S.2d 842 (N.Y. Sup. Ct. 2009).

[16] Id.; NYaffiliates.com, Merchants Removing NY Affiliates, http://www.abestweb.com/forums/showthread.php?t=105869 (last visited Nov. 29, 2010).

[17] R.I. Gen. Laws -§ 44-18-15 (2009); see also State of Rhode Island and Providence Plantations Department of Revenue, Important Notice: Definition of Sales Tax “Retailer” Amended, available at http://www.tax.state.ri.us/notice/Retailer_definition_NoticeC.pdf.

[18] N.C Gen. Stat. § 105-164.8(b)(3) (2009).

[19] North Carolina Department of Revenue, Sales Tax Law Changes, Form E-505 (8-09), Part II: Other Legislative Changes, available at http://www.dornc.com/downloads/e505_8-09.pdf.

[20] N.C Gen. Stat. § 105-164.3(33c) (2009).

[21] Jennifer Heidt White, Safe Haven No More: How Online Affiliate Marketing Programs Can Minimize New State Sales Tax Liability, 5 Shidler J. L. Com. & Tech. 21 (2009), (listing the following states as having introduced versions of the affiliate tax: Connecticut, Maryland, Minnesota, Tennessee, California, Hawaii, Mississippi, New Mexico, Vermont, Virginia, and Illinois).

[22] H.B. 10-1193, 67^th Gen. Assem., 2^nd Reg. Sess. (Colo. 2010), available at http://www.leg.state.co.us/clics/clics2010a/csl.nsf/fsbillcont3/B30F5741….

[23] Id.

[24] Direct Marketing Ass’n v. Huber, Order Granting Motion for Preliminary Injunction, 2011 WL 250556, Civil No. 10-cv-01546-REB-CBS, (D.Colo. 2011).

[25] 2009 OK H.B. 2359, (Feb. 1, 2010) available at http://webserver1.lsb.state.ok.us/textofmeasures/textofmeasures.aspx.

[26] Edward A. Zelinsky, The Paradoxes of Oklahoma’s Amazon Statute: Weak Duties, Expansive Coverage, Often Superfluous, Constitutionally Infirm, Cardozo Sch. L., Inst. Advanced L. Stud., Working Paper No. 315, at 17 (Oct. 2010).

[27] Michael Mazerov, Center on Budget and Policy Priorities, New York’s “Amazon Law”: An Important Tool for Collecting Taxes Owed on Internet Purchases, 1, July 23, 2009, http://www.cbpp.org/files/7-23-09sfp.pdf.

[28] H.R. 5660 at 1.

[29] 2009 Michigan Individual Income Tax Return MI-1040, line 25, available at http://www.michigan.gov/documents/taxes/MI-1040_305378_7.pdf.

[30] Minnesota, for example, exempts individuals with total purchased under $770 from paying the use tax, which is equivalent to $50 of use tax liability. Four other states have similar exemptions for individuals. See Nina Manzi, Use Tax Collection on Income Tax Returns in Other States, Research Department, Minnesota House of Representatives, *2, June 2010, available at http://www.house.leg.state.mn.us/hrd/pubs/usetax.pdf.

[31] Leslie J. Carter, Blowing the Whistle on Avoiding Use Taxes in Online Purchases, 2008 U. Chi. Legal F. 453–54 (2008).

[32] Google Retail Advertising Blog, Trend to Watch: Research & Purchase Process is Multi-Channel, (March 3, 2010), http://googleretail.blogspot.com/2010/03/trend-to-watch-research-purchas….

[33] Sara Rodriguez, Economic Climate Shifts Consumers Online, PriceGrabber.com (March 25, 2009), https://mr.pricegrabber.com/Economic_Climate_Shifts_Consumers_Online_Mar….

[34] Congressman Daniel Lungren, Lundgren Introduces Resolution to Protect Small Businesses and Entrepreneurs from New Sales Taxes, Feb. 16, 2011, http://lungren.house.gov/index.cfm?sectionid=39&sectiontree=6,39&itemid=759.

[35] H.R. 1570, 111^th Cong. (2010), available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills….

Standing and In Pari Delicto Issues Arising in Bankruptcy Cases

Congrats to Rui Li of the The University of Iowa College of Law -one of winners of the Spring 2011 National Law Review Student Legal Writing Competition: Rui’s topic addresses whether a bankruptcy trustee has standing to bring a suit on behalf of the debtor corporation against attorneys who allegedly helped that corporation’s management with the fraud.

1. Introduction

Corporate and managerial fraud is pervasive in today’s economic climate. When fraud leaves a company insolvent and forced to seek protection under the Bankruptcy Code, oftentimes bankruptcy trustees commence legal actions against attorneys to generate recoveries for the benefit of the debtor’s estate. A common scenario goes something like this: A company is in dire financial straits before the fraud or is created as a vehicle for the fraud. The defendant is the corporation’s attorney, who assists the corporation in the fraud. The attorney is hired to ensure the company’s compliance with existing law. The attorney does the bidding of the company’s management in pursuance of their fraud. After the company’s collapse, the bankruptcy trustee sues the attorney for fraud, aiding and abetting fraud and legal malpractice.

Drawing upon the equitable defense that bars recovery by a plaintiff bearing fault with the defendant for the alleged harm, common law principles of agency imputation, and the Constitutional requirement that a plaintiff has standing to sue, a defendant may move to dismiss the lawsuit on the grounds that the bankruptcy trustee lacks standing to sue.

This Note provides an analysis of the issue whether the bankruptcy trustee has standing to bring a suit on behalf of the debtor corporation against attorneys who allegedly helped that corporation’s management with the fraud.

**2. The In Pari Delicto Doctrine**

a) Background

In pari delicto means “at equal fault.” It is a broadly recognized equitable principle and common law defense that prevents a plaintiff who has participated in wrongdoing from recovering damages resulting from the wrongdoing.[1] The policy behind this doctrine is to prevent one joint wrongdoer from suing another for damages that resulted from their shared wrongdoing.[2] Therefore, if a bankruptcy trustee brings a claim against an attorney on behalf of the corporation, and if the corporation is involved in the corporation’s wrongful conduct which serves as the basis for the claim, the in pari delicto may bar the claim.

The use of the doctrine against bankruptcy trustees emerged in the wave of corporate frauds in the last few decades. This novel application required the introduction of an important new element: agency law. Under agency principles, if the principal acted wrongfully through an agent in the scope of that agency relationship, then the wrongdoing of the agent is attributed to the principal. Because the acts of corporate managers in the course of their employment are imputed to the corporation, and because a bankruptcy trustee “stands in the shoes” of a debtor corporation, the fraudulent acts of the debtor’s former managers will be imputed to the trustee—unless the trustee can show that management was acting entirely on its own interests and “totally abandoned” those of the corporation to break the chain of imputation.[3]

An analysis of the equitable defense in pari delicto at issue is separable from a standing analysis.[4] “Whether a party has standing to bring claims and whether a party’s claims are barred by an equitable defense are two separate questions, to be addressed on their own terms.”[5]

b) The Second Circuit’s Approach

In Shearson Lehman Hutton Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991), the Second Circuit adopted the controversial approach of treating in pari delicto as a question of standing rather than an affirmative defense. Specifically, the standing analysis in the Second Circuit begins with the issue of whether the trustee can demonstrate that the third party professional injured the debtor in a manner distinct from injuries suffered by the debtor’s creditors.[6] In many jurisdictions, the question of the trustee’s standing ends here.[7] In Wagoner, the Second Circuit went further and added a second inquiry that incorporates the equitable defense ofin pari delicto.[8] By combining these two issues, the Wagoner rule blends the in pari delicto question into a rule of standing.

In Wagoner, the sole stockholder, director, and president of a corporation had used the proceeds of notes to finance fraudulent stock trading.[9] After the corporation became insolvent, the trustee brought claims against the defendant, an investment bank, for breach of fiduciary duty in allowing the company’s president to engage in inappropriate transactions.[10] The court held that because the president participated in the alleged misconduct, his misconduct must be imputed to the corporation and the bankruptcy trustee. This rationale derives from the agency principle that underlies the application of in pari delicto to corporate litigants: the misconduct of managers within the scope of their employment will normally be imputed to the corporation.[11] The court ruled that the trustee lacked standing to sue the investment bank for aiding and abetting the president’s alleged unlawful activity.[12] By adopting the Wagoner rule, the Second Circuit upped the ante by making an equitable defense a threshold question of standing at the motion-to-dismiss stage, rather than an affirmative defense better resolved on summary judgment or at trial.

c) Approaches of Other Circuits

Although the Wagoner rule still prevails in the Second Circuit, a majority of other courts have declined to follow it, including the First, Third, Fifth, Eighth, Ninth and Eleventh Circuits. These circuits have “declined to conflate the constitutional standing doctrine with the in pari delicto defense.”[13] “Even if an in pari delictodefense appears on the face of the complaint, it does not deprive the trustee of constitutional standing to assert the claim, though the defense may be fatal to the claim.”[14]

The Eighth Circuit held that in pari delicto cannot be used at the dismissal stage.[15] On a motion to dismiss, the court is generally limited to considering the allegations in the complaint, which the court assumes to be true in ruling on the motion.[16] Because in pari delicto is an affirmative defense requiring proof of facts that the defendant asserts, it is usually not an appropriate ground for early dismissal.[17] An in pari delicto defense may be successfully asserted at the pleading stage only where “the facts establishing the defense are: (1) definitively ascertainable from the complaint and other allowable sources of information, and (2) sufficient to establish the affirmative defense with certitude.”[18] Thus, the in pari delicto defense is generally premature at this stage of the litigation, and the court must deny the motion to dismiss.

The existence of a possible defense does not affect the question of standing.[19]Standing is a constitutional question, and all a plaintiff must show is that they have suffered an injury that is fairly traceable to the defendant’s conduct and that the requested relief will likely redress the alleged injury. In this matter, the First, Third, Fifth, Eighth, and Eleventh Circuits’ approach is more convincing. Those courts hold that whether a trustee has standing to bring a claim and whether the claim is barred by the equitable defense of in pari delicto are two separate questions and that the in pari delicto defense is appropriately set forth in responsive pleadings and the subject of motions for summary judgment and trial.

3. Standing Issues The Trustees Face

a) Background

The next question is whether the bankruptcy trustee fulfills the constitutional requirement of standing. Article III specifies three constitutional requirements for standing. First, the plaintiff must allege that he has suffered or will imminently suffer an injury. Second, he must allege that the injury is traceable to the defendant’s conduct. Third, the plaintiff must show that a favorable federal court decision is likely to redress the injury.[20]

A critical issue in evaluating whether a trustee or receiver has standing to sue is whether the claim belongs to the corporate debtor entity or to the individual investors of the corporate debtor. The Supreme Court held in Caplin v. Marine Midland Grace Trust Co. of New York, 406 U.S. 416, 433-34 (1972), that a bankruptcy trustee has standing to represent only the interests of the debtor corporation and does not have standing to pursue claims for damages against a third party on behalf of one creditor or a group of creditors. Although the line is not always clear between the debtor’s claims, which a trustee has statutory authority to assert, and claims of creditors, which Caplin bars the trustee from pursuing, the focus of the inquiry is on whether the trustee is seeking to redress injuries to the debtor that defendants’ alleged conduct caused.[21]

b) The Shifting Focus of the Second Circuit

In Wagoner, the Second Circuit held that the corporation and the trustee did not have standing to bring a claim because a “claim against a third party for defrauding a corporation with the cooperation of management accrues to creditors, not to the guilty corporation.”[22] The rationale for this rule is “though a class of creditors has suffered harm, the corporation itself has not.”[23] Without cognizable injury, the trustee representing the debtor corporation failed to meet the constitutional standing requirement.

Commentators have criticized the Wagoner rule that there is no separate injury to the corporation on several grounds. First, the court’s finding that a corporation is not harmed when its assets are squandered effectively ignores the existence of the corporation during the bankruptcy process.[24] Furthermore, the Wagonercourt seems to acknowledge the trustee’s right to sue the guilty managers for damages done to the corporation. Such a construction leads to the absurd result that when management and its accomplices defraud a corporation, management can be sued on behalf of the corporation for the harm caused to the corporation, but the accomplices cannot be sued on behalf of the corporation because the corporation was not harmed.[25] Recognizing the faults of this rule, the Second Circuit recognized that there was “at least a theoretical possibility of some independent financial injury to the debtors” as a result of the defendant’s aid in the fraud.[26] Nevertheless, the court denied the plaintiff’s standing, relying on the observation that any damage suffered by the debtor was passed on to the investors, and “there was likely to be little significant injury that accrues separately to the Debtors.”[27] In other words, most of the alleged injuries in Hirsch were suffered by third parties, not by the debtors themselves. The Second Circuit shifted the focus of the Wagoner rule from lack-of-separate-injury (the first inquiry of theWagoner rule) to the in pari delicto (the second inquiry) in Breeden v. Kirkpatrick & Lockhart LLP, 336 F.3d 94 (2d Cir. 2003). In that case, the court denied the trustee standing, holding that even if there was damage to the corporation, the trustee lacked standing because of the debtor’s collaboration with the corporate insiders.[28]

c) Approaches of Other Circuits

In Lafferty, the creditors’ committee brought an action against the debtor’s officers, directors and outside professionals, alleging that through participation in a fraudulent Ponzi scheme, the defendants wrongfully prolonged the debtor’s life and incurred debt beyond the debtor’s ability to pay, ultimately forcing the debtor into bankruptcy.[29] The Lafferty court articulated different kinds of harms to the corporation: (1) fraudulent or wrongful prolongation of an insolvent corporation’s life, (2) prolongation that causes the corporation to incur more debt and become more insolvent, and (3) diminution of corporate value had prolongation not occurred.[30] Recognizing that conduct driving a corporation deeper into debt injures not only the corporate creditors, but the corporation itself, the Third Circuit held the committee had standing to sue the outsiders on behalf of the debtor.[31]The court also noted that although the Tenth and Sixth Circuits had applied the in pari delicto doctrine to bar claims of a bankruptcy trustee, those courts assumed that the bankruptcy trustee at least has standing to bring the claim.[32]

The Eighth Circuit held that a trustee who had alleged sufficient injury traceable to the actions of the defendants had standing to sue.[33] The court held that the defendant law firm and attorneys participated in stripping the corporation’s assets and that the injury was traceable to the activities of the lawyers who engineered the transaction to the detriment of their client.[34] In addition, the Eighth Circuit noted that the Third Circuit in Lafferty and the Ninth Circuit (in Smith v. Arthur Andersen LLP 421 F.3d at 1004) rejected the argument that a cause of action for harm to an insolvent corporation belongs to the creditors rather than the corporation. The Eighth Circuit adopted the rationale of Lafferty that simply because the creditors may be the beneficiary of recovery does not transform an action into a suit by the creditors.[35]

The Ninth Circuit found that the trustee had standing to pursue breach of contracts and duties against attorneys, auditors and investment bankers where, if defendants had not concealed the financial condition of debtor, the debtor might have filed for bankruptcy sooner and additional assets might not have been spent on a failing business.[36] “This allegedly wrongful expenditure of corporate assets qualifies as an injury to the firm which is sufficient to confer standing upon the Trustee.”[37] The court stated that “We rely only on the dissipation of assets in reaching the conclusion that the debtor was harmed.”[38] “A receiver has standing to bring a suit on behalf of the debtor corporation against third parties who allegedly helped that corporation’s management harm the corporation.”[39]

To sum up, when a director or officer enlists the help of attorneys to misstate the financial health of a company, it causes significant harm to a corporation. Harms include: (1) the fraudulent and concealed accrual of debt which can lessen the value of corporate property, (2) legal and administrative costs of bankruptcy, (3) operational limitations on profitability, (4) the undermining of business relationships, and (4) failed corporate confidence.

If court were to afford standing to trustee, third parties would be deterred from negligent, reckless, or other wrongful behavior. It will provide a means for increasing attorneys’ liability for the wrongs they commit. While limitless liability for attorneys is not the solution, increasing liability will require attorneys to answer in court when they fail to detect fraud or manipulation on the part of directors and officers that a reasonable attorney would discover.

4. Conclusion

Attorneys are equipped with the tools to prevent fraud. An attorney may always report fraud to the appropriate authority or refuse to participate in the fraud. However, attorneys may not want to jeopardize important client relationships unless the consequence of inaction makes reporting more beneficial. Given the turmoil of the financial markets since 2008, increased liability for attorneys could help alleviate corporate fraud and bolster consumer confidence in this distressed market.

For the above reasons, the bankruptcy trustee has standing to bring a suit on behalf of the debtor corporation against attorneys who allegedly helped that corporation’s management with the fraud.

[1] Terlecky v. Hurd (In re Dublin Sec., Inc.), 133 F.3d 377, 380 (6th Cir.1997).

[2] In re Parmalat Sec. Litig., 383 F. Supp. 2d 587, 596 (S.D.N.Y. 2005).

[3] Wight v. Bank American Corp., 219 F.3d 79, 87 (2d Cir. 2000).

[4] See generally Jeffrey Davis, Ending the Nonsense: the In Pari Delicto Doctrine Has Nothing to Do with What is Section 541 Property of the Bankruptcy Estate, 21 Emory Bankr.Dev. J. 519 (2005); Gerald L. Baldwin, In Pari Delicto Should Not Bar a Trustee’s Recovery, 23-8 Am. Bankr.Inst. J. 8 (2004); Tanvir Alam, Fraudulent Advisors Exploit Confusion in The Bankruptcy Code: How In Pari Delicto Has Been Perverted To Prevent Recovery for Innocent Creditors, 77 Am. Bank. L.J. 305 (2003); Robert T. Kugler, The Role of Imputation and In Pari Delicto in Barring Claims Against Third Parties, 1 No. 14 Andrews Bankr.Litig. Rep. 13 (2004);Making Sense of the In Pari Delicto Defense: “Who’s Zoomin’ Who?” 23 No. 11 Bankr. Law Letter 1 (Nov.2003).

[5] Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co.,267 F.3d 340, 346-47 (3d Cir.2001).

[6] Wagoner, 944 F.2d at 118.

[7] R.F. Lafferty & Co., 267 F.3d at 340.

[8] Wagoner, 944 F.2d at 118.

[9] Id. at 116.

[10] Id. at 116-17.

[11] Wight, 219 F.3d at 86.

[12] Wagoner, 944 F.2d at 120.

[13] In re Senior Cottages of America LLC, 482 F.3d 997, 1003 (8th Cir. 2007) (collecting cases).

[14] Id. at 1004.

[15] Id. at 1002.

[16] Wilchombe v. Tee Vee Toons. Inc., 555 F.3d 949, 959 (11th Cir. 2009).

[17] Knauer v. Jonathon Roberts Financial Group, Inc., 348 F.3d 230, 237 n. 6 (7th Cir. 2003).

[18] Gray v. Evercore Restructuring, LLC, 544 F.3d 320, 325 (1st Cir. 2008).

[19] Novartis Seeds, Inc. v. Monsanto Co., 190 F.3d 868, 872 (8th Cir. 1999).

[20] Allen v. Wright, 468 U.S. 737, 756-58 (1984).

[21] Smith v. Arthur Andersen, LLP, 421 F.3d 989, 1002 (9th Cir. 2005).

[22] Wagoner, 944 F.2d at 120.

[23] Id.

[24] Jeffrey Davis, Ending the Nonsense: The In Pari Delicto Doctrine Has Nothing to Do with What Is § 541 Property of the Bankruptcy Estate, 21 Emory Bankr. Dev. J. 519, 525 (2005).

[25] Id. at 527.

[26] Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1087 (2d Cir. 1995).

[27] Id.

[28] Id. at 100.

[29] Lafferty Co., 267 F.3d at 348-49.

[30] Id.

[31] Id. at 354.

[32] Id. at 358.

[33] In re Senior Cottages Of America, LLC, 482 F.3d 997.

[34] Id.

[35] Id. at 1001.

[36] Smith v. Arthur Andersen, LLP, 421 F.3d at 1003 (9th Cir. 2005).

[37] Id.

[38] Id. at 1004.

[39] Id.

“Innocent” Criminals: Criminal Copyright Infringement, Willfulness and Fair Use

The National Law Review would like to congratulate Charles Francis Scott of Pace University School of Law one of our Spring 2011 Student Legal Writing Contest Winners. Charles’ topic is the “willfullness” prong of criminal copyright infringement:

I. INTRODUCTION

On November 17, 2010, Gawker Media LLC published on its popular blog, Gawker, excerpts of Sarah Palin’s unreleased book America By Heart: Reflections on Family, Faith and Flag.[1] In response to the release, Palin tweeted, “Isn’t that illegal?”[2] Defending itself, Gawker mockingly wrote to Palin in a post titled Sarah Palin is Mad at Us for Leaking Pages From Her Book, telling her to “take a moment to familiarize yourself with the law. . . . Or skip the totally boring reading and call one of your lawyers. They’ll walk you through it” and attached pages on the copyright law’s fair use doctrine.[3] After Gawker refused to remove the excerpts from its blog, Palin’s publisher, HarperCollins, filed suit against Gawker and obtained a preliminary injunction on November 20, 2010.[4] By November 23, 2010, Gawker agreed to keep the material off its website for good and settled the suit with HarperCollins.[5] Ignoring the underlying political and ideological tension between Gawker and Palin,[6] this incident highlights a very important issue: the complex and commonly misunderstood fair use doctrine.

The fair use doctrine has been a large source of legal uncertainty and, as a result, has led many civil copyright infringement suits to settle out of court.[7] While it might be desirable that civil suits are settled out of court for judicial efficiency, the doctrine’s uncertainty poses a problem when fair use is used as an affirmative defense against criminal charges of copyright infringement under 17 U.S.C. § 506.[8] In order to convict an individual of criminal infringement, the individual must have willfully infringed a copyright (1) for commercial or financial gain; (2) reproducing or distributing copies with a total retail value over $1000; or (3) making an unpublished work publicly available on a computer.[9] The fair use doctrine states that there are certain uses, subject to a four factor balance test, where an individual can use or copy a copyrighted work without infringing.[10] The fair use defense would then argue that either (1) the use was not infringing because it was a fair use; or (2) the individual did not willfully infringe because he or she believed the use was a fair use.

A problem arises when an individual believes in good faith his or her copying is a fair use but does not pass the factor test and is actually infringing. Depending on the courts interpretation of “willfully,” this good faith, but mistaken belief, can be the difference between conviction and freedom. As illustrated in the Gawker-Palin example, even sophisticated parties, who presumptively have personal legal counsel, misinterpret the bounds of the fair use doctrine. If sophisticated individuals find difficulty in the nuances of the doctrine, what can be expected of the unsophisticated individual? Since the mens rea of willfully is attached to a section 506(a) charge, barring a bad faith fair use defense, will a fair use defense always absolve a defendant?

This article will look at the fair use doctrine as an affirmative defense against the criminal charge of copyright infringement under section 506(a) and whether it serves as a suitable defense within the statute, or whether the statute needs to be revised to avoid the problems created by the fair use doctrine. Part II will give a brief background of section 506(a) for a charge of criminal copyright infringement and analyze the case law defining “willfulness” generally and its application to the mens rea of section 506(a). Part III will review the fair use doctrine and the issues created when fair use is used as a defense. Part IV will briefly examine certain policy considerations in relation to criminal copyright infringement. Finally, this article will conclude that the fair use doctrine is too vague of a doctrine to be an effective defense and may reduce section 506(a) to a “toothless” statute.[11] As a result, the statute should be amended by increasing the monetary criminal trigger from $1,000 to at least $25,000 and the term “willfully” needs to be defined in accordance with the majority view.

II. § 506(a) BACKGROUND AND WILLFULNESS STANDARD

Criminal copyright infringement is codified under 17 U.S.C. § 506(a) and the punishment guidelines is under 18 U.S.C. § 2319.[12] Under section 506(a), criminal copyright infringement is anyone who willfully infringes a copyright (1) for commercial or financial gain; (2) reproducing or distributing copies with a total retail value over $1000; or (3) making an unpublished work publicly available on a computer if that person knew the work was intended for commercial distribution.[13] To prove willful infringement, evidence of reproduction or distribution of a copyright work will not be sufficient.[14] The government has the burden to prove all four elements which are: (1) a valid copyright; (2) infringement of that copyright; (3) willfulness; and (4) one of the qualifying violations of section 506(a)(1)(A)-(C).[15] The first two elements are the same that must be shown in a civil infringement case.[16] The difference between civil and criminal infringement is the addition of the third and fourth element.

Unlike civil infringement, which is a strict liability offense, criminal infringement requires that the government prove the individual acted willfully. However, the definition of “willfulness” has been left up to the courts’ interpretation since Congress failed to define it.[17] Unfortunately, “willfulness” has long been a thorn in court’s side when used in the context of criminal law.[18] It was not untilUnited States v. Moran[19]that the court was confronted with interpreting the vague term’s meaning under section 506(a).

In Moran, Moran was a full-time police officer and owner of a “mom and pop” video rental store.[20] Moran made a practice of purchasing legal videos, making a single duplicate of the original, renting the copy, and keeping the original to “insure” the video from theft or damage.[21] Moran testified that he believed his actions were legal.[22] He argued that “the word ‘willful’ implies the kind of specific intent . . . which is to say, a voluntary, intentional violation of a known legal duty.”[23] The government argued that willful only meant “an intent to copy and not to infringe.”[24] In coming to its decision, the court looked to a prior Supreme Court case dealing with the term “willfully” in a criminal statute.

In Cheek v. United States,[25] Cheek was charged with willfully failing to file federal income taxes and willfully attempting to evade his taxes.[26] Cheek claimed that he believed the tax code was unconstitutional and therefore believed he did not have to pay taxes.[27] The court held that while the “general rule that ignorance of the law or a mistake of law is no defense to criminal prosecution,” an exception is made when the term “willfully” is used in complex criminal statutes.[28] Due to the complexity of the tax code, “willfulness . . . simply means a voluntary, intentional violation of a known legal duty.”[29] The government then has the burden to prove that the defendant knew of the duty and voluntarily and intentionally violated it.[30] Therefore, “a good faith belief that one is not violating the law negates willfulness, whether or not the claimed belief or misunderstanding is objectively reasonable.”[31]

Using the reasoning of Cheek, the Moran court was persuaded that “willfully” carried the same meaning under 17 U.S.C. § 506(a) and was similarly exempt from the presumption that ignorance of the law or mistake of the law is no defense.[32] Accordingly, the court held that Moran’s lack of sophistication, in addition to the totality of the circumstances, negated the willfulness requirement.[33] However, it should be noted, the lack of willfulness does not eliminate civil liability for copyright infringement.[34]

The holding in Moran has since become the majority view, while the minority view interprets “willfully” as only the intent to copy.[35] These two views are drastically different; from who carries the burden of proof to the consequence facing an individual who believed his use was protected by fair use. Unlike the clear complexity of the tax code, the fair use doctrine appears straight-forward but is deceptively complex.[36] Faced with this complexity, the statute should be amended to define “willfully” in accordance with the majority view and create consistency throughout the courts.

The outcomes of a fair use balancing test can be unpredictable and creates uncertainty in its application.[37] Applying the minor’s view, “innocent” infringers face the possibility of being labeled criminals. By adopting the majority’s definition of “willfully”, prosecution will have the burden of showing that an individual has themens rea warranting criminal punishment. Additionally, by codifying the majority’s definition, there will be minimal disruption to current law.

III. FAIR USE

Section 107 of the Copyright Act allows for the use of a copyrighted work for limited purposes such as “criticism, comment, news reporting, teaching . . ., scholarship, or research.”[38] Whether that use is eligible for the fair use defense depends on the court’s evaluation of four factors set forth in section 107.[39]These four factors are: (1) the purpose and character of the use (i.e. whether such use is of a commercial nature or for nonprofit purposes); (2) the nature of the copyright (i.e. whether the work is fact based or creative); (3) the amount and substantiality of the portion used in relation to the copyrighted work as a whole; and (4) the effect of the use upon the potential market for or value of the copyrighted work.[40] While the courts have held that all the factors must be examined and weighed together, the fourth factor has been given the most weight.[41]

This first factor of the fair use doctrine is usually split into two separate questions. The first question asks whether the use is “transformative,” meaning, whether it “supersede[s] the objects’ of the original creation.”[42] The second question asks whether the use is “commercial.”[43] Since “transformative” and “commercial” are general terms and are susceptible to various interpretations, the first factor can be confusing. In Sony Corp. of America v. Universal City Studios,[44]the court acknowledged that time-shifting[45] was an acceptable “private, noncommercial” transformative use “in the home”.[46] However, when compared to BMG Music v. Gonzalez,[47]which held that Gonzalez’s music downloading on a try-before-you-buy basis was a commercial use, the line between commercial and noncommercial, especially for private, personal use, becomes hazy. Both seem like private, noncommercial uses in the home for personal use, but Gonzalez’s actions supplant her actually purchasing music.[48] This creates a fine distinction that the unsophisticated individual could misunderstand. What exactly is commercial if personal use can be both commercial and noncommercial? Is loading potentially infringing content on YouTube or a similar streaming website commercial if the user does not have a financial interest in the website?[49]

If an individual posts a clip to his blog or YouTube of a scene from his favorite TV show, saying just that, he could believe he is protected by the fair use doctrine. He believes the use is noncommercial because he’s not receiving any money from it and he is only using a small portion of the show. He could believe that he’s making commentary on the piece by saying it is his favorite piece. Finally, since he is not making any money from posting the video, he does not believe he has any effect on the copyrighted work’s market. Within a 180 day period it is very possible that the video is viewed well over 100,000 times. The $1000 or even the $2500 threshold under section 506(a) could easily be attained.

It is feasible that a court could find fair use under these facts or slightly different facts because of the variables of the balancing test.[50] One commentator likened the fair use balancing test to “balancing a dinner plate on the pointy end of a nail.”[51] Since each evaluation of fair use is fact specific, and all the factors vary in weight depending on those facts, the outcomes are sometimes unpredictable. As such, the unpredictability of fair use seems to breed fertile ground for an individual to make a good faith mistake in evaluating his or her actions.

Depending on the district an individual is in, and the interpretation of “willfulness” observed, this mistake can be the difference between walking away a free man or going away a felon. If the court is within the majority, an individual can theoretically always negate “willfully,” absent evidence that the individual’s belief was not in good faith. “If a person can claim ‘fair use’ and escape criminal penalties, then the law has no teeth since alleged infringers will invariably assert this defense.”[52] Alternatively, if the court is within the minority, an individual will not be allowed a mistake defense and will only avoid conviction if the fair use analysis is successful. These two outcomes are polar opposites; one is too lenient while the other is too severe.

IV. POLICY CONSIDERATIONS

Is the infringement of $1000 worth of copyrighted material worth labeling that individual a felon or criminal, even if he did not believe his actions were illegal?[53] “Felon is a word that should be reserved for individuals committing crimes that damage a victim beyond repair through civil means.”[54] Civil remedies are more suitable in such a case. Incarceration for up to three years for the infringement of $2500 worth of copyrighted material[55] is excessive when civil remedies are available to recover those damages. If the basis of enacting criminal laws are for “deterring future crimes, stigmatizing offenders, expressing community values, extracting retribution, reforming the offender, and so on,”[56]what are the “retributive function[s] . . . these statutes convey?”[57] If the offender does not know his actions are illegal, the statute does not achieve these goals. Furthermore, public opinion does not believe the punishment fits the crime in such low level infringement, as evidenced by the outcry over a Twilight fan’s arrest for taping a birthday party during a viewing of the film “New Moon.”[58]

Additionally, the cost attributed to the enforcement and incarceration of such an offender is far too high. Beyond the cost of prosecution, the costs of incarcerating the offender far exceeds the low infringing $2500 threshold. Based on California’s 2008-2009 Annual Costs to Incarcerate an Inmate in Prison, the average cost per inmate per year is about $47,000.[59] Theoretically, for a three year sentence, the government would be paying over $140,000 of taxpayer money to incarcerate a non-violent criminal for a $2500 infringement. Additionally, the non-violent criminal would now be exposed to the dangers and violence inherent in prison.[60]

V. CONCLUSION

While these low threshold cases with fair use issues are typically not prosecuted,[61]charges are still filed.[62] The statute has the ability to make criminals out of people that do not know their actions are illegal or believe that they are legal. By raising the threshold of section 506(a)(1)(B) to at least $25,000, the statute would be better able to avoid prosecution of “innocent” infringers. The other subsections of 506 would still allow for punishment of individuals selling infringing materials for personal financial gain and individuals distributing unpublished material prior to commercial releases (i.e. leaking music albums, movies, or books). With these two other options available, raising the threshold would not make prosecution any more difficult.

Finally, “willfully” needs to be defined in the statute in accordance with the majority view. One action should not be more or less culpable depending on the circuit where it is committed. By defining “willfully” in the statute, all circuits would be in conformity and there would be no discrepancies between courts. Furthermore, if the purpose of the criminal copyright infringement statute is to educate, prevent, and deter, the public needs to know what is and what is not criminal. For that reason, the definition of “willfully” is necessary to educate and assist in deterring future criminal infringement.

[1]Maureen O’Conner, Sarah Palin’s New Book: Leaked Excerpts, Gawker, (Nov. 17, 2010, 1:50 PM), http://webcache.googleusercontent.com/search?q=cache:TxlEfXyJDUMJ:gawker….

[2]NY Judge Orders Gawker To Pull Palin Book Pages, Associated Press, (Nov. 20, 2010),http://www.google.com/hostednews/ap/article/ALeqM5giNUABDpwRGZATlokAAN5D….

[3]Id.

[4]Sarah Wheaton, Gawker Ordered to Remove Palin Book Excerpts, N.Y. Times, Nov. 20, 2010, 10:45 PM,http://mediadecoder.blogs.nytimes.com/2010/11/20/gawker-ordered-to-remov….

[5]Jeremy E. Peters & Julie Bosman, Palin’s Publisher and Gawker Settle Case, N.Y. Times, November 24, 2010,http://www.nytimes.com/2010/11/25/business/media/25gawker.html?src=busln.

[6]See generally Pareene, Palin: Scared of Asians?, Gawker, (Dec. 4, 2009, 1:39 PM), http://gawker.com/5419113/palin-scared-of-asians; Foster Kamer, Are Sarah and Todd Palin Getting A Divorce?, Gawker, (Aug. 1, 2009),http://gawker.com/5327957/are-sarah-and-todd-palin-getting-a-divorce; John Cook, Please Turn the Governor of Alaska’s Family Into A Television Program. Thank You., Gawker, (Mar. 12, 2009, 11:13 AM),http://gawker.com/5168742/please-turn-the-governor-of-alaskas-family-int….

[7]See generally Diane L. Kilpatrick-Lee, Criminal Copyright Law: Preventing A Clear Danger To The U.S. Economy Or Clearly Preventing The Original Purpose Of Copyright Law?, 14 U. Balt. Intell. Prop. L.J. 87 (2005); Anthony Falzone, Diddy Could Save Sampling, Slate, (Nov. 2, 2007, 7:16 AM),http://www.slate.com/toolbar.aspx?action=print&id=2177238.

[8]17 U.S.C. § 506 (2008).

[9]Id.

[10]17 U.S.C. § 107 (1992).

[11]See generally Ting Ting Wu, The New Criminal Copyright Sanctions: A Toothless Tiger?, 39 IDEA 527 (1999).

[12]18 U.S.C. § 2319 (2008).

[13]17 U.S.C. § 506(a)(1)-(2) (2008).

[14]Id.

[15]See Daniel Newman, Mangmang Cai & Rebecca Heugstenberg, Intellectual Property Crimes, 44 Am. Crim. L. Rev. 693, 717 (2007).

[16]See id. at 718.

[17]§ 506(a)(3).

[18]See Brian P. Heneghan, The Net Act, Fair Use, and Willfulness – Is Congress Making A Scarecrow of the Law?, 1 J. High Tech. L. 27, 34 (2002). Judge Learned Hand stated that willfulness is “an awful word! It is one of the most troublesome words that I know. If I were to have the index purged, ‘willful’ [sic] would lead the rest in spite of its being at the end of the alphabet.” Id. at n64.

[19]757 F. Supp. 1046 (1991).

[20]Id. at 1047.

[21]Id. at 1047-48.

[22]Id. at 1048.

[23]Id.

[24]Id.

[25]498 U.S. 192 (1991).

[26]Id. at 194.

[27]Id. at 195-97.

[28]Id. at 199-200.

[29]Id. at 200.

[30]Id. at 201.

[31]United States v. Moran, 757 F. Supp. 1046, 1049 (1991).

[32]Id.

[33]Id. at 1052.

[34]Kilpatrick-Lee, supra note 7, at 106.

[35]Newman, supra note 14, at 721.

[36]Heneghan, supra note 17, at 35-36.

[37]See infra Part III.

[38]17 U.S.C. § 107 (2007).

[39]Id.

[40]Id. §§ 107(1)-(4).

[41]Campbell v. Acuff-Rose Music Inc., 510 U.S. 569, 578 (1994).

[42]Campbell, 510 U.S. at 584.

[43]17 U.S.C. § 107(1) (2007). See also Harper & Row, Publishers, Inc. v. Nation Enters., 471 U.S. 539, 562 (1985) (“every commercial use of copyrighted material is presumptively an unfair exploitation of the monopoly privilege that belongs to the owner of the copyright”).

[44]See Sony Corp. of Am. v. Universal City Studios, 464 U.S. 417 (1984).

[45]Time shifting is the act of recording a TV show on a VHS tape for later private viewing.

[46]Id. at 442-43.

[47]430 F.3d 888 (7th Cir. 2005).

[48]Id. at 890.

[49]See generally Michael S. Sawyer, Copyright: Note: Filters, Fair use & Feedback: User-Generated Content Principles and the DMCA, 24 Berkeley Tech, L.J. 363 (2009); Edward Lee, Warming Up To User-Generated Content, 2008 U. Ill. L. Rev. 1459 (2008).

[50]See generally Jeremy Scott, “Leave Them Kids Alone” A Proposed Fair Use Defense For Noncommercial P2P Sharing of Copyrighted Music Files, 3 Fla. Int’l U. L. Rev. 235 (2007).

[51]See Eric Spiegelman, Sarah Palin and Gawker to Debate Freedom and the Constitution, The Awl, (Nov. 22, 2010), http://www.theawl.com/2010/11/sarah-palin-and-gawker-to-debate-freedom-a….

[52]Heneghan, supra note 17, at 36.

[53]17 U.S.C. § 506(a)(1)(B) (2008).

[54]Kilpatrick-Lee, supra note 7, at 117.

[55]18 U.S.C. § 2319(c)(2) (2008).

[56]Geraldine Scott Moohr, The Crime of Copyright Infringement: An Inquiry Based on Morality, Harm, and Criminal Theory, 83 B. U. L. Rev. 731, 748 (2003).

[57]Kilpatrick-Lee, supra note 7, at 118.

[58]The charges were dropped after holding the woman for two days. SeeShanna Schwarze, ‘New Moon’ Taping May Put Woman In Prison, CNNEntertainment (Dec. 4, 2009, 6:28PM),http://www.cnn.com/2009/SHOWBIZ/Movies/12/04/new.moon.arrest/; Amanda Bell, Charges Against Accused ‘The Twilight Saga: New Moon’ ‘Pirate’ Dropped, examiner.com (Dec. 11, 2009, 4:36PM), http://www.examiner.com/twilight-in-national/charges-against-accused-the… Jacqueline D. Lipton, Coypright’s Twilight Zone: Digital Copyright Lessons From The Vampire Blogosphere, 70 Md. L. Rev. 1, 38-42 (2010).

[59]California’s Nonpartisan Fiscal and Policy Advisor, Legislative Analyst’s Office, California’s 2008-2009 Annual Costs to Incarcerate an Inmate in Prison(2009),http://www.lao.ca.gov/laoapp/laomenus/sections/crim_justice/6_cj_inmatec….

[60]See Heneghan, supra note 17, at 39-43.

[61]Computer Crime and Intellectual Property Section, U.S. Dep’t of Just., Prosecuting Intellectual Property Crimes Manuel 67-68 (2001).

[62]See supra note 57.

More Than Just An Algorithm: Reconciling The Necessity For Disaggregating The Business Method, With Bilski’s Abstract Test

The National Law Review would like to congratulate Andrew L. Schwartz of Hofstra Law School one of our Spring 2011 Student Legal Writing Contest Winners. Andrew’s topic is the business method patent.

INTRODUCTION

As the airplane’s utility spread to the public sector, the 1940’s witnessed the sky’s transformation into the new highway. Like any new frontier and innovation, there was a need for regulation and legal guidance. Fortunately, property law had covered the topic since the 18^th century. Cuius est solum, eius est usque ad coelum et ad inferos, whoever owns the soil, it is theirs up to Heaven and down to Hell.[1]The Supreme Court however did not agree with such dated application.[2]The court reasoned that categorizing air travel with ground travel under current property law would be naive. The two categories possessed different interest and policy consideration. Unification of the two, under traditional property laws, would essentially defeat air travel’s value and purpose. Such application had “no place in the modern world”[3]. The court made it clear that new innovation required new regulation and new legal guidance. Instead of fitting innovation into the law, new laws are created to fit innovation.

To promote, and protect innovation, for years American inventors have relied on the system of intellectual property and the patent system. The patent system, a once humble and optimistic institution, has evolved far beyond its beginnings. When the last patent act was passed over a half a century ago, aspirations were high. The 1950’s saw an innovation boom that inspired some of the most integral foundations for modern technology.[4] Proponents of the patent system promoted exposure and accessibility for innovation, while discouraging concealment and private use.[5] Assuming the excitement of the era, congress eagerly looked to protect “anything under the sun that is made by man”.[6] However with the eruption of financial and software innovation in recent years, one would be hard-pressed to find the 1950’s anything-and-everything sentiment in today’s patent office.

In the eyes of the patent office, financial and software innovation is commonly referred to as a business method. Subject to 35 U.S.C §101 and classified under Class 705, a business method patent is “the generic class for apparatus and corresponding methods for performing data processing operations.”[7] Software is a set of logical instructions, intended for a computer, made to perform computations, comparisons and sequential steps in order to process and produce a desired output.[8]Financial innovation, centuries older than software, began as basic mathematical principles.[9] Contemporary financial innovation however, has grown to enormous complexities. Fashioned from a set of multifaceted mathematical algorithms, the innovations have become so advanced that it is near impossible to solve without the aid of a computer.[10] Essentially, in the law’s view, today’s financial innovation is software.[11]

The business method has conflated financial and software innovation under the association of complex algorithms. While under a legal lens software and financial algorithms are near inseparable, the makings and interests of their respective innovations are however quite different. For instance, a large internet corporation may attempt to patent an online shopping method for common consumers;[12] while a large financial firm may attempt to patent a system of asset pooling for large mutual funds.[13] From the components that build the algorithm, to the industries effected by the patents, it is difficult not to acknowledge the distinctions between the two scenarios. The current patent system however does not recognize such distinctions. In both scenarios the algorithms are to be evaluated as business method patents.

Because of the realistic distinctions between financial and software innovation, formulating a cohesive judicial policy for the business method would seem destitute. Patent litigation over the past forty years has been frustrated with judicial attempts to reconcile both financial and software innovations under the business method patent. The most recent efforts in the ongoing business method saga produced the Abstract test for patentability assessment. The Abstract test was created by the Supreme Court’s ruling Bilski v. Kappos.[14] While the test is still in its early stages of development, lower courts have been hard pressed to reconcile financial and software innovation under the business method using the Abstract test.[15]

History has produced an ambiguous interpretation of financial and software innovation that fails to fit the enthusiastic “anything under the sun” patent system of the 1950’s. It is clear that the development of financial and software innovation has outgrown the traditional business method classification. The business method has “no place in the modern world”[16] and needs categorical disaggregation among financial and software innovation. Disaggregation would not only better serve the time and principles that each innovation represents, but simplify the Abstract test while preserving its purpose.

This article will examine the necessity for the disaggregation of the business method. The first section will evaluate the judicial history and evolution of the business method leading up to the Bilski decision. The second section will discuss the Bilski decision and the Abstract test. The third section will contemplate the current future of the Abstract tests. The last section of the article will discuss how the business method and the Abstract test can be clarified in disaggregating the business method into financial and software innovation.

I. HISTORY: THE GUIDEPOSTS: 1972-2008

The history of contemporary algorithmic innovation began in the 1970’s when the Supreme Court twice considered business method patents. Both decisions held the innovations unpatenable. The first decision, Gottschalk v. Benson, was decided in 1972.[17]The Supreme Court considered whether algorithmic based software for converting binary code was patentable. In a six justice majority, the court held the method unpatenable, unless “in connection with a digital computer”, because it “would wholly pre-empt the mathematical formula and in practical effect would be a patent on the algorithm itself”.[18]The decision confirmed that algorithms, made akin to software by the court, standing alone, were unpatenable subject matter. [19]

While algorithms alone were unpatenable, the question existed of whether bringing a physical component into the application would preclude a patentability. Six years after Benson, the Supreme Court returned to the business method issue and addressed such question. InParker v. Flook, the Supreme Court considered whether an algorithmic based method for triggering an alarm system, used to signal irregular conditions in a catalytic conversion process, was patentable.[20]In a seven justice majority, the Court held the innovation unpatenable. Although the alarms inclusion meant the innovation wasn’t wholly algorithmically based, the majority realized the only novel element in Flook’s innovation was the algorithm itself.[21] It would have appeared that the patent system’s hole had been filled. The courts would not be fooled by crafty lawyering and mirrors attempting to hide an algorithm amongst physical components. After Benson and Flook, it appeared software and algorithms, were to be treated like any other mathematical formula, unpatenable.

Hopes of patenting an algorithm under the business method reemerged only four years later in the Supreme Court case Diamond v. Diehr.[22]Once again an application was presented, part physical, part algorithm. The invention used the Arrhenius Equation to calculate the operation timing on a physical rubber press. As the rubber curing process stood well known in the industry, clearly the only new innovation in the patent application was the algorithm itself.[23]However, in a five justice majority, the application was deemed acceptable. Arguably marking the first time an application containing software was considered statutorily patentable. Although the rulings in Benson and Flook were not overruled by the Diehr decision, it appeared that the physical component ambiguities after Benson had not truly been resolved.

After Diehr, the patent system became a virtual wild west. Floods of “ridiculous and truly absurd” business method applicants were submitted to the patent office.[24]The era was epitomized with a 1994 application from the software titan IBM.[25]The invention set out a group algorithms loaded onto a physical readable storage device. The physical component that was able to pass muster under Benson and Flook, a floppy disk. The application’s approval gained such recognition that it was even endowed its own business method idiom, a Beauregard claim.[26]After dilution of the Flook’s unpatenable ruling, the despondent future of the business method patent herald through the financial and software communities.[27]

The circular timeline of judicial clarification surfaced once again in 1998 with the case of State Street v. Signature Financial Group.[28]The court found Signature Financial’s financial purposed algorithm, one that moved assets into mutual funds to take advantage of tax benefits, to be patentable. The State Street holding marked two significant chapters in business method history. The first was the court’s explicit recognition of the business method patent.[29]The court found that such a category was no less patentable than any other subject matter under Section 101. State Street’s judicial endorsement of the business method patent, once again, propagated a flood of financial and software patent applications.[30]The second major significance of the State Street decision was in the court’s clarification of business method eligibility. The court held that the new test for eligibility was to be the Useful, Concrete and Tangible Result test. Although the test could hardly be awarded a bright line denomination, it marked the first judicial canon to reconcile Benson, Flook and Diehr. However, despite the court’s best efforts, the test still granted several questionable patents approval, many lacking any hint of a physical component.[31]

II. CREATION OF THE ABSTRACT TEST: IN RE BILSKI & BILSKI V. KAPPOS

Ten years after the State Street decision, judicial clarification poignantly returned to the Federal Court of Appeals. Finding an opportunity to reevaluate its holding in State Street and its significances over the past ten years, the court, sitting en banc, adjudicated In Re Bilski.[32]The court’s holding not only rejected State Street’s Useful, Concrete and Tangible Result test that had reigned supreme for ten years, but went as far to replace it with a new test for business method eligibility. The new test, the Machine-or-Transformation test, held that a business method patent was patentable subject matter if it 1) was applied by use of a machine, or else 2) transforms an article from one thing or state to another. Was the court’s new test a judicial endorsement of the Beauregard claim, or was it carefully worded to avoid the question of patentability with an additional physical component? It would have appeared that, once again, the courts had clarified one complication, while subsequently creating another.

The thematic clarification of business method decisions past came to one of its most pivotal moments in 2009 when the Supreme Court granted writ of certiorari for Bilski’s appeal.[33]From Silicon Valley to Wall Street, software and financial innovators alike held their breath awaiting the decision. Mounting rumors held that the court would possibly eliminate the business method patent altogether.[34]While some justices of the dissent agreed with the business method’s eradication, the majority felt otherwise.[35]Delivered by Justice Kennedy, the majority opined, that business methods are indeed patentable; Bilski’s application however was not.

Bilski had developed a hedging algorithm to eliminate volatility in consumer energy costs. Using the Monte Carlo method and historical weather data, energy prices would be hedged with weather futures to lock in a more stable and predictable energy bill. The algorithm’s complexities went far beyond any pen and paper, and the necessity for a computer was evident. Although there was an implied necessity for a physical component (a computer), the majority still found the algorithm unpatenable. The majority reasoned that Bilski’s innovation was an abstract idea. Reiterating established ‘precedent’, as if such a rule were ostensibly written and obvious already, the court reasoned that business method patents are limited by “laws of nature, physical phenomena, and abstract ideas”.[36]The Machine-or-Transformation test developed in In Re Bilski was no longer to be a determinative test in patentability, but rather a “useful and important clue” to the inclusive Abstract test.[37] The court continued to disregard the continuance of other tests that have marked business method history through the years, declaring that “nothing in today’s opinion should be read as endorsing the Federal Circuit’s past interpretations of § 101. See, e.g., State Street.”[38]And in one sentence ten years of State Street and its progeny were erased.

The Bilski Supreme Court failed to clarify a definition of their Abstract test, both in its criteria’s inclusions and omissions. The court rather left such task of interpretation to the lower courts in coming years, advising them on a case by case basis to return to the legal “guideposts”[39]of Benson, Flook, and Diehr. Justice Potter’s illustrious commentary rang ever present, “I can’t define it, but I know it when I see it”.[40] The business method was, once again, afflicted with yet another ambiguous interpretation.

III. THE CURRENT FUTURE OF THE BUSINESS METHOD

In patent applications to come, federal courts are left with the assignment of interpretation mandated by the powers above. Courts now sit in a post-Bilski era with the future of the business method patent in their discretion. While courts have taken time to acknowledge the inconclusiveness of the Bilski decision[41], others have used the opportunity to expand its meaning. In a recent decision by the Federal Court of Appeals, the eligibility of algorithms specifically was discussed.[42]Not surprisingly opting to use the ‘guidepost’ of Diehr, the court held that “algorithms and formulas, even though admittedly a significant part of the claimed combination, do not bring this invention even close to abstractness that would override the statutory categories and context”.[43]Even the most confident and charitable views of the Bilski decision and its progeny echo a notice of future complications, some which have already begun to surface. [44]

Verified by a circular history blemished with flaws, mistakes, and corrections, the current business method system’s stability is noticeably far from safe. While financial and software innovation has slowly, over the years, conjoined in the eyes of the court under the business method, the culture and society of their respective subscribers is quickly diverging. Such policy considerations, which have all but been neglected in past business method decisions, must be recognized before history reprises itself.

In efforts of slowing the arbitrary attachment of physical components (Beauregard claims), the Supreme Court in Bilski retained the possibility that a purely intangible may gain patentability.[45]However, in a digital age, it is almost inherent that financial and software innovation will rely on a physical element, likely a computer. Even under the court’s pragmatic recognition of the times, Bilski’s Abstract test is still extremely comprehensive. Susceptible to a wide array of differing interpretations, in coming years the Abstract test is capable of rooting itself into case law far beyond its intended purpose, possibly precluding any software or financial innovation entirely. To better limit the scope to which the Abstract test reaches, its application should be tested to separate confines, software and financial innovation. The question ‘what is an abstract business method’ is extremely different than ‘what is abstract financial innovation’ and ‘what is abstract software innovation’. Because software and financial innovations are inherently different, from their components to the industries they affect, the Abstract test will take on different considerations when applied to each individually.

IV. DISAGGREGATION: A SOLUTION

A. FINANCIAL ABSTRACT TEST

The assertion that all mathematical formulas are made of components in existence, workings of nature that have yet to be discovered, is a naive assertion in light of contemporary financial innovation.[46]The quintessential example for the unpatentability of mathematical formulas is Einstein’s relativity formula.[47]Einstein did not invent the formula; he simply codified and arranged components of nature in an assignable formula. Mass, energy, and the speed of light all existed in nature eons before Einstein was even born. Although contemporary financial innovations are based in principles of mathematics, the components and interactions of the numbers in the algorithm can hardly be described as derivatives of nature.

Far from nature, financial innovations operate solely on man-made financial markets. The extent of financial innovation is limited to the markets and can only exclusively function on this man-made medium.[48]For example, Bilski’s use of weather futures in his algorithm would not have even been possible during the time of Diehr, Benson or Flook because weather futures existence has only been recognized on the market since 1996.[49]If the market or weather futures ceased to exist tomorrow, Einstein’s relativity formula would certainly still be comprehensible, Bilski’s algorithm would not.

Because market components and financial algorithms are not of nature, does not mean they cannot be natural relative to the market and its culture. Maintaining the ability to freely use the public utilities and its components has always been an essential consideration in patentability.[50] This is where the Abstract test in financial innovation can differentiate itself from the Abstract test in software innovation. If a patent were to impede and dominate a natural market component from its intended purpose and use, then such patent would likely fail the Abstract test. The Supreme Court toiled with such reasoning but ultimately carried it in an unusual direction.

Bound to traditional business method policy considerations of both financial and software innovation, and unable to reflect financial market specifics, the Bilski court was forced to reason broadly. The court stated that Bilski sought to patent “the concept of hedging risk…hedging is a fundamental economic practice…allowing petitioners to patent risk hedging would pre-empt use of this approach in all fields, and would effectively grant a monopoly over an abstract idea”.[51] Application of the court’s wide comprehensive view on any patent will ultimately render it an abstract idea. Can a machine for bending metal be unpatenable because bending is fundamental physical practice?[52]Instead of looking to whether patenting Bilski’s algorithm would have created a monopoly over a natural market strategy, the court should have looked to whether patenting Bilski’s algorithm would have created a monopoly over a natural market component. If Bilski’s algorithm positioned itself to inhibit the public use of weather futures, then the Abstract test would have denied patentability. If Bilski’s algorithm used weather futures in such a way that was useful, novel and non-obvious, while still allowing for its natural use in the market, then the Abstract test would have allowed patentability. Reducing any algorithm to its most basic functions will appear as attempts at privatization of a public utility and fail the Abstract test. Only when the court is given range to apply the Abstract test to the specifics at hand (i.e. financial innovation specifically) can it properly operate.

With such ambiguous decisions as Bilski, financial innovation in private industry has been strained. Over the past years financial innovation has given rise to high frequency, black box and the white box trading.[53]All three concepts revolve around the use of an algorithms operating millisecond market transactions, consistently adjusting to market reactions. While the extent of high frequency trading is generally unknown, the same cannot be said for its presence.[54]Uncertainties in the patent system’s protection have driven financial innovators into hiding. For fear of competitor plagiarism, private firms using algorithms are seldom to share their innovations with the world.[55]Because of a lack of protection, the utility and public benefit of some of these innovations may never be known. Consider the Black-Scholes model, the base for many contemporary algorithms, and arguably one of the most provocative financial innovations of the past century.[56]Once used as a secret investing tool, the algorithm’s utility now goes far beyond the financial sector (ironically one alternative use is in patent valuation[57]). Failing to provide a stronger outline to patentable criteria will only push innovators further into hiding, inhibiting any progress in financial innovation.

The Abstract test applied separately to financial innovation would help facilitate reassurance in the patent system. The Abstract test for financial innovation would be tried against the interests of the market and private industry. Like any public domain, the market invites innovation as long as it does not inhibit the public’s use.[58]A patent application attempting to corner off a common public utility would be abstract. In the private industry’s interest, any application that would potentially destroy the opportunity for progress would be abstract. Evaluating abstractness in financial innovation separately would suit the patent system and innovation in a way the traditional business method system could not.

B. SOFTWARE ABSTRACT TEST

The struggle between anti-software patent movements and patent proponents has grown significantly as more and more innovations stem from the digital age.[59]While the Bilski decision has almost solidified software as patentable, the Abstract test may serve as an elementary compromise when applied to software innovation separately.

Unlike its financial counterpart, software algorithms do not operate on a public medium such as the market. Software is bound to the rules and procedures of a given programming language. Languages are constantly being created, evolving and improving. The Java language, currently the most popular programming language, was only released in 1995 with its most recent release February 15^th 2011.[60]Because the medium on which software innovation operates is moving at an enormously high rate (significantly more so than financial innovation) the innovation itself must move just as fast.

Like its financial counterpart, software also has its own natural components. The Abstract test applied to software would evaluate a patent and its implications under the software culture. If the patent would preclude a natural software component, the Abstract test would reject patentability. However, because of the speed of software evolution, what is regarded as innovation today may easily be common industry practice tomorrow. As patents protection lasts for twenty years, the test for abstractness must possess a sense of foresight. An overly lenient application of the Abstract test in software innovation would inhibit further innovation in later years rather than facilitate it. Consider a software’s spell checker component. The spell checker is only forty years old, but an almost natural component in any contemporary software algorithm.[61]Patenting such component would certainly be abstract and inhibit further innovation. Only when the use of the natural component in software innovation is useful, novel and non-obvious, with a tremendous amount of creativity, can the Abstract test allow patentability.[62]Because of the fluid environment that software innovation operates in, the threshold for abstractness would be significantly lower than financial innovation. This consideration only further proves the need for disaggregation.

Unlike financial innovation, software innovation is not as easily kept secret. The public market acts as a blanket for financial innovations used by traders, with a petty possibility of reverse engineering. The private software industry however, serves no protection to software innovation as it is much more readily reversed engineered and plagiarized. [63] This puts software innovators at a disadvantage, as hiding their innovation is not even an option. Without secrecy as an alternative, the patent system must work more readily to incentivize innovation without slowing it down. On the same token because software innovations are plainly exposed, it pushes innovators to persistently improve so that they may claim the alpha position amongst competitors.

CONCLUSION

While Bilski’s Abstract test is far from definitive criteria, it is th e hand that has been dealt. Application of the Abstract test to software and financial innovations separately alleviates a large amount of ambiguity. Disaggregating the business method and applying the Abstract test separately allows for different considerations and thresholds for each innovation. Attention to the components and the industry of the individual innovations restores the patent system to its intended purpose, which the traditional business method has failed to do. With such differences, aggregating software and financial innovation under the business method is impractical. The traditional business method truly has “no place in the modern world”.[64]

[1]John G. Sprankling, Owning the Center of the Earth, 55 UCLA L. Rev. 979, 980 (2008).

[2]United States v. Causby, 328 U.S. 256, 261, 66 S. Ct. 1062, 1065, 90 L. Ed. 1206 (1946).

[3]Id. at 261.

[4]Inventions include: 1951- VTR Video Tape Recorder, 1954-Solar Cell, 1955-Fiber Optics, 1959-Microchip. Cavendish, Marshall, Inventors and Inventions 372-73 (2^nd ed. 2007).

[5]Edward C. Walterscheid, Within the Limits of the Constitutional Grant: Constitutional Limitations on the Patent Power, 9 J. Intell. Prop. L. 291, 300 (2002).

[6]The Supreme Court held that Congress chose very expansive language in the patent statute, 35 U.S.C. §101, such that “anything under the sun that is made by man” is patentable subject matter. Diamond v. Chakrabarty, 447 U.S. 303, 100 S. Ct. 2204, 65 L. Ed. 2d 144 (1980).

[7]35 U.S.C.A. § 101 (2010).

[8]Chittenden Trust Co. v. King, 143 Vt. 271, 272, 465 A.2d 1100, 1100 (1983).

[9]The first financial patent was issued on March 19, 1799, for a method for “Detecting Counterfeit Notes.” State Street: Business Method Patents Can They Be A Boardwalk Address?, 688 PLI/Pat 455 , 471 (2002).

[10]William Krause, Sweeping the E-Commerce Patent Minefield: The Need for A Workable Business Method Exception, 24 Seattle U. L. Rev. 79, 101 (2000).

[11]Id.

[12]Amazon.com, Inc. v. Barnesandnoble.com, Inc., 73 F. Supp. 2d 1228 (W.D. Wash. 1999) vacated, 239 F.3d 1343 (Fed. Cir. 2001).

[13]State St. Bank & Trust Co. v. Signature Fin. Group, Inc, 149 F.3d 1368, 1373 (Fed. Cir. 1998) abrogated by In re Bilski, 545 F.3d 943 (Fed. Cir. 2008).

[14]Bilski v. Kappos, 130 S. Ct. 3218, 177 L. Ed. 2d 792 (2010).

[15]“our focus on our muddy, conflicting, and overly formulaic rules.” Arlington Indus., Inc. v. Bridgeport Fittings, Inc., 2010-1025, 2011 WL 179768 (Fed. Cir. Jan. 20, 2011).[16]Causby, supra note 2.

[17]Gottschalk v. Benson, 409 U.S. 63, 93 S. Ct. 253, 34 L. Ed. 2d 273 (1972).

[18]Id. at 72.

[19]Id.

[20]Parker v. Flook, 437 U.S. 584, 98 S. Ct. 2522, 57 L. Ed. 2d 451 (1978).

[21]“Respondent’s application simply provides a new and presumably better method for calculating alarm limit.” Id. at 595.

[22]Diamond v. Diehr, 450 U.S. 175, 101 S. Ct. 1048, 67 L. Ed. 2d 155 (1981).

[23]“There is no suggestion that there is anything novel in the instrumentation of the mold, in actuating a timer when the press is closed, or in automatically opening the press when the computed time expires.” Id. at 209.

[24]In re Bilski, 545 F.3d 943, 1004 (Fed. Cir. 2008) aff’d but criticized sub nom. Bilski v. Kappos, 130 S. Ct. 3218, 177 L. Ed. 2d 792 (U.S. 2010).

[25]In re Beauregard, 53 F.3d 1583 (Fed. Cir. 1995).

[26]Electronic and Software Patents: Crafting The Claims, 909 PLI/Pat 979, 909 PLI/Pat 979 , 1000 (2005).

[27]“it is clear after Flook that the board’s conclusion that patent protection is proscribed for all inventions “algorithmic in character” is overbroad and erroneous.” Application of Johnson, 589 F.2d 1070, 1075 (C.C.P.A. 1978).

[28]State St. Bank supra note 13.

[29]Id.

[30]Stobbs, Gregory A., Business method patents 17,(2002).

[31]Amazon.com, Inc, supra note 12.

[32]In Re Bilski, supra note 24.

[33]Bilski, supra note 14.

[34]Ryan Paul, SCOTUS to hear Bilski case, may be huge for software patents,June 2, 2009, http://arstechnica.com/tech-policy/news/2009/06/scotus-to-hear-bilski-ma….

[35]Bilski, supra note 14.

[36]Id. at 3321.

[37]Id.

[38]Id. at 3321.

[39]Id.

[40]Jacobellis v. State of Ohio, 378 U.S. 184, 196, 84 S. Ct. 1676, 1682, 12 L. Ed. 2d 793 (1964).

[41]Arlington Indus.,supra note 15.

[42]Research Corp. Technologies, Inc. v. Microsoft Corp., 627 F.3d 859, 864 (Fed. Cir. 2010).

[43]Id.

[44] “I come from the camp that anything is patentable if you put enough money behind it, but what you might just get at the end of the day is something that won’t hold up in court. Bilski is a great example that no one really understands where patent law should head or the basics of patent decisions.” Keyson, Lauren, NYTECH.org Ecamines Software and Financial Patents, Jan. 24, 2011, http://nyconvergence.com/2011/01/nytech-org-examines-software-and-financial-patents.html

[45]Bilski, supra note 14.

[46]Durham, Alan L., Patent Law Essentials: A Concise Guide¸24(2004).

[47] Diehr supra note 22.

[48]Smith, Mark B., A History Of The Global Stock Market: From Ancient Rome To Silicon Valley(2004).

[49]Jewson, Stephen, Brix, Anders, Weather Derivative Valuation: The Meteorological, Statistical, Financial And Mathematical Foundations(2005).

[50]“patents shall not remove knowledge from the public domain or restrict free access to knowledge already available to the public.” Efthimios Parasidis, A Uniform Framework for Patent Eligibility, 85 Tul. L. Rev. 323, 330 (2010).

[51]Bilski, supra note 14.

[52]U.S. Patent No. 4356716 (issued Nov. 2, 1982).

[53]Citadel Inv. Group, LLC v. Teza Technologies LLC, 398 Ill. App. 3d 724, 725, 924 N.E.2d 95, 97 (Ill. App. Ct. 2010) appeal denied, 236 Ill. 2d 551, 932 N.E.2d 1028 (2010).

[54]Jeremy Grant, ECB Warns of High Speed Trading Risks, Feb. 24, 2011, http://www.ft.com/cms/s/0/e23ddc24-4044-11e0-9140-00144feabdc0.html#axzz1EwJH4xaz.

[55]Goldman counsel asked to seal courtroom during disclosure of trading practices. United States v. Aleynikov, 737 F. Supp. 2d 173, 174 (S.D.N.Y. 2010).

[56]Geisst, Charles R,Encyclopedia Of American Business History (Vol. 2 2006).

[57]Berman, Bruce M., From ideas to assets: investing wisely in intellectual property 532 (2002).

[58]A Uniform Framework for Patent Eligibilitysupra note 48.

[59]Paul Krill, Red Hat, Google Challenge Software Patents, Feb. 3, 2011, http://www.networkworld.com/news/2011/020311-red-hat-google-challenge-software.html?hpg1=bn.

[60]TIOBE SOFTWARE, TIOBE Programming Community Index, Feb. 2011, http://www.tiobe.com/index.php/content/paperinfo/tpci/index.html.

[61]Reiffin v. Microsoft Corp., 158 F. Supp. 2d 1016, 1020 (N.D. Cal. 2001).

[62]McIntyre v. Double-A Music Corp., 179 F. Supp. 160, 161 (S.D. Cal. 1959).

[63]Davidson & Associates v. Jung, 422 F.3d 630, 639 (8th Cir. 2005)

[64]Causby, supra note 2.

From Trips to ACTA: Establishing the Intent to Uphold Access to Medicine in the Face of Ambiguity

The National Law Review would like to congratulate Guadalupe A. Lopez of the American University Washington College of Law one of our Spring 2011 Student Legal Writing Contest Winners. Guadalupe writes about generic drugs and patents and the distribution of pharmaceuticals in developing countries:

Introduction

The numbers speak for themselves. Each year, over 9.5 million people die due to infectious diseases for which there exists medication – most live in developing countries.ⁱ Currently, there are over 33 million people around the world living with HIV/AIDS,ⁱⁱ 70 percent of whom are in dire need of anti-retroviral medication but not receiving it.ⁱⁱⁱ This has been attributed, in part, to the lack of affordable healthcare in developing countries, along with the high drug prices associated with monopolies provided by pharmaceutical patents.^iv

Studies demonstrate that there is a significant change in the price of a drug once its patent expires, allowing its generic version to be legally manufactured and introduced into a given market.^v The introduction of a generic drug often results in the reduction of prices anywhere between 22% and 88%, depending on the type of drug and the number of generic manufacturers producing it.^vi In some instances, even the threat of introducing a generic drug into a market will be enough to significantly lower the price of its patented version.^vii For this reason, it is in the best financial interest of pharmaceutical companies to acquire and maintain the highest levels of intellectual property rights (“IPR”) protection on their patents. In furtherance of that objective, pharmaceutical companies have actively engaged in campaigns, both domestically and around the world, aimed at preventing generic manufacturers from accessing global drug markets.^viii Unfortunately, this comes at a high cost to patients who are in need of treatment and cannot afford the patented versions of these medicines. This paper will address this concern by explaining how the pursuit of high levels of IPR protection has exacerbated the inaccessibility of medication by keeping more affordable, generic drugs off the market.^ix This has been largely possible due to a narrow application of the Trade Related Aspects of Intellectual Property Rights Agreement (“TRIPS Agreement”), as well as efforts to establish the highest possible levels of IPR protection, led mainly by industrialized nations.

The first section of this paper will provide an introduction to the TRIPS framework as well as a timeline of international events leading to the Doha Declaration on the TRIPS Agreement and Public Health (“Doha Declaration”). This was a declaration by all members of the TRIPS Agreement reaffirming their obligation to protect public health through the use of provisions referred to as “TRIPS flexibilities.” The second section explains that despite the Doha Declaration, certain TRIPS flexibilities have been undermined through the implementation of bilateral trade agreements with developing countries, and regulations within regional trading blocs providing vigorous protection of IPRs.^x These trade agreements and regulations contain “TRIPS-Plus” provisions demanding higher levels of IPR protection than those required by the TRIPS Agreement itself.^xi In essence, they have been seen as attempts to circumvent the obligations agreed to during the Doha Declaration, acknowledging that public health issues take precedent over IPRs. The third section of this paper introduces the Anti-Counterfeiting Trade Agreement (ACTA) recently negotiated by the world’s most industrialized nations, and presents the arguments raised in opposition to the accord. Many have argued that due to the special interests behind ACTA’s negotiating countries, this agreement will have a detrimental impact on developing countries, as they will be forced to adopt a framework of heightened IP standards to which they did not explicitly assent.^xii The last section argues that despite the clear threats posed by ACTA, negotiating countries have expressed a clear intent to uphold access to medicine principles as asserted in the Doha Declaration. However, because many of the ACTA negotiations have been held behind closed doors, there is no record that reflects this intent outside of the public statements made by country representatives. The section proposes creating an unofficial drafting history for ACTA based on amendments made to various drafts of the text as well as public statements released by the parties. This drafting history will provide assistance when interpreting any ambiguity within ACTA that may be used to impede access to medicine or undermine any of the obligations made under the Doha Declaration.

I. The implementation of TRIPS and the resulting need for the Doha Declaration on public health

A. The Development of the TRIPS Agreement

During the 1980s, a number of corporate actors mobilized together after realizing that they shared the common goal of increasing the protection of their intellectual property rights.^xiii This alliance was comprised of trans-national corporations from a variety of sectors, among them agricultural chemical producers, software producers, entertainment providers, and brand-name pharmaceutical providers.^xiv After successfully lobbying their interests at a domestic level, these actors began seeking a way to further expand the protection of their interests by pursuing higher levels of IPR protection outside the United States.^xv They did so by creating a strategy to link IP with trade, two areas of law which until then, were vastly unrelated. In addition, this interest group also formed strong political ties within the U.S. and gained considerable support with the U.S. government, particularly the Office of the US Trade Representative.^xvi Through transnational mobilization and aggressive lobbying of various governments, international organizations and private sectors, this coalition managed to include its newly formulated trade-based IP regime in the agenda for the GATT’s Uruguay Round of Multilateral Trade Negotiations (“Uruguay Round”) held in 1995.^xvii

During the Uruguay Round, the United States persistently promoted the adoption of a new global intellectual property regime.^xviii Some scholars have noted that many countries assented to the TRIPS Agreement in hopes that a multi-lateral rule based system would eliminate the US’ coercive economic policy.^xix As a result, many developing countries were at a disadvantage during TRIPS Agreement negotiations due to the asymmetry in bargaining power vis-à-vis more industrialized countries. Furthermore, developing countries were at an additional disadvantage because their negotiators lacked the necessary training in the area of intellectual property essential to negotiating a new set of IP standards.^xx Daniel Gervais explains that as a result, industrialized countries made very few concessions during the negotiations while developing countries were “forced to accept a package that they perhaps did not fully understand and yet, contained a set of foreign IP norms which they now had to implement.”^xxi This Uruguay Round of negotiations resulted in what is known today as the Trade-Related Aspects of Intellectual Property Rights Agreement- adopted and put into force in 1994.^xxii

The TRIPS Agreement was an effort to implement a global intellectual property rights regime and establish what industrialized countries believed should be the minimum levels of IPR protection required of all countries before acceding as members of the WTO.^xxiii As a result, the TRIPS Agreement obligated developing nations to enforce levels of IPR protection similar to those adopted by highly industrialized nations, despite the lack of development in their own domestic IP laws.^xxiv Included as part of the TRIPS Agreement were provisions requiring a 20-year term of protection for patented medication, which pharmaceutical companies argued were necessary to sustain innovation and fund research and development for future pharmaceutical products.^xxv Along with these higher levels of protection, however, came huge impediments to the accessibility of essential medication in developing nations.

B. Access to Medicine Consequences

The implementation of the TRIPS Agreement provided pharmaceutical companies with a legal and effective monopoly over their products due to the period of protection granted to their products before the introduction of any generic competitors.^xxvi This meant that name-brand pharmaceutical companies were able to maintain high drug prices so long as they were still under the 20-year patent protecting their products. Within developing countries, however, this additional term of patent protection ultimately resulted in the overall reduction of affordable medicine.

This monopoly over medicines and prices proved to be devastating during the late 1990s when the HIV/AIDS epidemic was reaching its peak.^xxvii It was at this point that developing countries realized the extent of the serious access to medicine implications that accompanied the adoption of the TRIPS Agreement. Developing countries, particularly South Africa, took initiatives to address the crisis by providing low-cost medication to its citizens and by issuing compulsory licenses for anti-retroviral HIV/AIDS medication.^xxviii These efforts were met with fierce resistance from pharmaceutical companies and retaliation in the form of a lawsuit by the U.S. government.^xxix The outcome was a wave of public outrage and widespread protests against the U.S. and pharmaceutical companies, largely led by developing countries, civil activists, and international organizations.^xxx Due to mounting international pressure, the U.S. government eventually caved, withdrawing the lawsuit against South Africa as well as the trade sanctions previously implemented against it.^xxxi At this point, it became clear that there was a much-needed reassessment of the objectives and interpretation of the TRIPS Agreement.

C. A Call for the Doha Declaration on the TRIPS Agreement and Public Health

In an effort to address the public health concerns resulting from the implementation of the TRIPS Agreement, the WTO introduced a “development round” in 2001 known as the Doha Declaration on the TRIPS Agreement and Public Health (“Doha Declaration”).^xxxii During this round, members of the WTO unanimously recognized the need of developing countries to address serious public health issues such as HIV/AIDS, tuberculosis, malaria and other epidemics.^xxxiii The Doha Declaration thus stands for the assertion that the TRIPS Agreement should not prevent any WTO member from taking measures to protect the health of its citizens. In doing so, the Declaration reaffirmed each member’s right to use the safeguards within the TRIPS Agreement without risking retaliation from other WTO members.^xxxiv Specifically, the Doha Declaration reaffirmed a member’s right to parallel import medication under Article 6 of the TRIPS Agreement, and issue compulsory licenses under Article 31.^xxxv

Parallel Imports

Article 6 of the TRIPS Agreement provides WTO members with the right to import patented drugs after they have been sold in other markets.^xxxvi This provision essentially allows WTO members to import brand-name drugs from other countries where it is being sold at a lower retail price.^xxxvii This means that once a brand-name drug is legally sold in one country, the patent holder “exhausts” his rights over the product, at which point the drug may be re-sold and exported to other countries.^xxxviii This TRIPS flexibility thus provides developing countries the option to purchase medicine from foreign markets where it is being sold at a lower price than within its own domestic market. By taking advantage of this flexibility, developing countries with limited healthcare resources are able to import cheaper medicine, thereby increasing its affordability and overall access to its citizens.

Compulsory Licensing

Another safeguard reaffirmed during the Doha Declaration is a country’s right to issue compulsory licenses in cases of national emergencies, granted through Article 31 of the TRIPS Agreement.^xxxix Article 31 allows a country to license the manufacturing of a generic drug while its brand-name version is still under patent without the express consent of the patent holder.^xl Compulsory licenses have proven to be one of the most effective tools for providing life-saving drugs, such as anti-retroviral medication, to patients in developing countries, particularly within Africa.^xli They have led to greater competition in the drug market by allowing generic drugs to compete with patented pharmaceutical products, driving down its overall cost.^xlii This leads to more affordable prices for both citizens and governments providing healthcare services in the country where it is issued. The issuance of compulsory licenses have proved so effective in reducing drugs costs that even the mere threat of issuing one will often compel pharmaceutical companies to drastically reduce their prices in an effort to keep generic manufacturers off the market.^xliii

The use of TRIPS flexibilities such as the two discussed above have been praised and strongly encouraged by non-profit organizations and civil society groups working to promote access to medicine in developing countries.^xliv Despite the progress made, however, there is growing concern that these efforts have been undermined through pressure from bilateral and regional trade agreements, domestic legislation, and new forms of multilateral agreements such as ACTA.

II. Circumventing the Doha Declaration Through TRIPS-Plus Agendas

The TRIPS Agreement succeeded in implementing a new global regime of heightened standards of intellectual property right protection. However, it also left room for countries to implement measures to protect the public health of its citizens through provisions known as “TRIPS flexibilities.”^xlv Through TRIPS flexibilities, governments are free to address issues arising from the lack of innovation for diseases affecting their populations, coupled with high pharmaceutical prices and restrictions on availability.^xlvi Despite these flexibilities though, recent free trade agreements (FTA) between developed and developing countries, particularly those with the US, have been criticized for restricting the adoption of these TRIPS flexibilities.^xlvii By including “TRIPS-Plus” provisions into their FTAs, developed nations have narrowed the application of TRIPS flexibilities, thereby posing dangers to the production and availability of medicines in developing countries. More recently, regional trading blocs, such as the EU, have similarly begun to draw criticism due to the inclusion and strict enforcement of TRIPS-Plus measures within its borders.

A. TRIPS-Plus Obligations in Free Trade Agreements

Since the Doha Declaration and the reinforcement of TRIPS flexibilities, several industrialized countries have continued to vigorously represent the commercial interest of pharmaceutical companies in trade negotiations with developing countries.^xlviii By using access to their markets as a form of inducement, developed countries have been able to secure higher levels of IPR protection, known also as “TRIPS-Plus” measures, through trade agreements.^xlix As reported by Oxfam International, some FTAs have contained TRIPS-Plus provisions providing for the following increased protection:

Expanded scope over pharmaceutical patents (covering new therapeutic uses of existing medicines and formulations);
Limitations on the grounds for issuing compulsory licenses to highly restrictive emergencies, government non-commercial use, and competition cases;
Barring parallel imports of patented medicines sold more cheaply elsewhere;
Extending patent monopolies for administrative delays by patent offices and drug regulatory authorities.^l

In a report prepared for House Representative Henry Waxman in 2005, the Committee on Government Reform declared that “[C]ontrary to the Doha Declaration, U.S. trade negotiators have repeatedly used trade agreements to restrict the ability of developing nations to acquire medicines at affordable prices.”^li Although Congress requires that the U.S. Trade Representative (“USTR”) comply with the Doha Declaration on Public Health, nearly every free trade agreement negotiated in the past decade by USTR has included TRIPS-Plus provisions significantly restricting the manufacturing of generic drugs.^lii In addition, the USTR has previously announced its TRIPS-Plus agenda as well as a commitment to pursue levels of IPR protection in accordance with those of the pharmaceutical industry.^liii Oxfam International asserts that this commitment to higher standards of IPR protection can be explained by the close relationship between the USTR and the pharmaceutical industry within the U.S.^liv

Special 301 Watch List

One effective tool that the U.S. has used to enforce the TRIP-Plus provisions within its FTAs is the Special 301 Watch List (“Special 301”).^lv The Special 301 is a report mandated by the U.S. Trade Act of 1974 through which the USTR assesses whether countries are complying with IPR standards contained in bilateral or multi-lateral agreements with the U.S.^lvi If the USTR finds that a country is not in compliance with such standards, it sends a “warning” through the Special 301 Report threatening to impose trade sanctions pursuant to the U.S. Trade Act.^lvii Oxfam International argues that the U.S. has used the Special 301 process to pressure countries into unilaterally implementing TRIPS-Plus provisions.^lviii In addition, the Government Accountability Office has noted that while the overall number of countries listed on the Special 301 has decreased, the number of countries cited for pharmaceutical-related issues has increased.^lix One example of this, sparking controversy among various members of Congress, was the placement of Thailand on the Special 301 Watch List for having issued a compulsory license for HIV/AIDS medication in 2006.^lx

After this incident sparked international attention, however, Congress took it upon itself to adjust the USTR’s attitude on how it proceeded to negotiate bilateral trade agreements.^lxi Since then, the USTR has made significant concessions by providing greater flexibility to provisions that at one point may have impeded access to medicine in developing countries.^lxii These efforts have been reflected in amendments made to the US-Colombia and US-South Korea FTAs, making them more amenable to the adoption of TRIPS flexibilities.^lxiii

B. TRIPS-Plus Obligations in Regional Agreements: The Case of EU Council Regulation 1383/2003

In addition to TRIPS-Plus obligations contained in FTAs, some industrialized nations have enacted far-reaching TRIPS-Plus measures as part of their domestic legislation. As noted by the International Centre for Trade and Sustainable Development (ICTSD), the European Union (EU) has been particularly active in vigorously enforcing “maximalistic” standards of IPRs within its own region.^lxiv To illustrate, the EU implemented Council Regulation 1383/2003, which involves the searches, seizures, and destruction of goods suspected of infringing intellectual property rights by customs officials throughout its borders.^lxv This regulation explicitly grants IP right holders the ability to prohibit the import or export of goods suspected of infringing patents, copyrights, and trademarks to and from the EU.^lxvi Because this regulation is directed at all imports and exports, it has been greatly criticized by advocacy groups concerned with access to medicine due to its obstruction to the transit of pharmaceutical goods passing through EU territory.^lxvii In doing so, EC 1383/2003 comes into conflict with Article V of the GATT, which establishes the principle of freedom of transit through the territory of each contracting party.^lxviii The regulation also conflicts with the obligations to public health undertaken by all WTO members under the Doha Declaration.

In particular, the implementation of EC 1383/2003 has resulted in several detentions of shipments of generic medication that did not meet the heightened IP standards within the EU, but were otherwise legal in their importing and exporting countries.^lxix This incident sparked widespread controversy as most of the shipments were traveling from India and destined to developing countries – such as Mexico, Brazil, Nigeria, Peru, Colombia and Ecuador – and only briefly traveling through the EU.^lxx While most of the shipments were only temporarily seized, some of them were in fact destroyed for not complying with IPR standards within the EU, pursuant to EC 1383/2003.^lxxi The EU defended its actions as an unfortunate result of the MEDI-FAKE initiative, which targets illegal counterfeit medicines entering the EU.^lxxii Still, critics argue that these detentions, all involving generic medication, were neither incidental nor accidental, but were rather opportunistic acts of IPR holders in an effort to obstruct generic competition through false counterfeiting allegations.^lxxiii Whichever may be the case, these incidents demonstrate EU officials generalized the use of the term “counterfeit,” thereby implicating other forms of IP infringements having nothing to do with counterfeiting (such as patent violations). The EU seizures have resulted in a great deal of debate over the consequences that EC 1383/2003 (and similar policy) has on freedom of transit principles and on the overall impeding effect it can have on access to medicine. This brings us to ACTA.

III. The Anti-Counterfeiting Trade Agreement

The Anti-Counterfeiting Trade Agreement (“ACTA”) is a multilateral agreement currently being negotiated between the world’s most industrialized nations,^lxxiv and aimed at combating counterfeit goods.^lxxv It represents one of the most important attempts to negotiate a “North to North” agreement on issues of intellectual property rights protection after the TRIPS Agreement. For this reason, ACTA is seen by critics as an attempt to create a new template of TRIPS-plus protection outside any interference from developing countries, multilateral organizations, or civil society in general. Parties to these negotiations assert, however, that the objectives behind the implementation of ACTA are to “establish an international framework for participating governments to more effectively combat the proliferation of counterfeiting and piracy” and to “define effective procedures for enforcing existing intellectual property rights.”^lxxvi

To many of its critics though, ACTA reflects a fairly clear intent to expand TRIPS standards and even remove some of its flexibilities.^lxxvii In particular, ACTA has been criticized by civil society groups and developing countries for threatening the freedom of transit of generic medicines. India and China are some of ACTA’s most vocal opponents; they argue that such measures do not take into consideration the interests of developing countries or their commitments to the Doha Declaration on Public Health.^lxxviii These countries also warn that ACTA would create trade restrictions for WTO members who are not negotiating parties of ACTA, yet who are still subjected to obligations beyond those required by the TRIPS Agreement.^lxxix

The criticism over ACTA has not stopped there. Other institutions that have taken issue with ACTA have included the World Trade Organization and the World Intellectual Property Organization. These organizations argue that ACTA goes far beyond what was needed to combat counterfeiting and piracy, and in the process, is creating a new regime of IPR protection that will undermine multilateral institutions such as themselves by weakening their authority.^lxxx

A. Access to Medicine Threats Posed by ACTA

The most serious concern raised by access to medicine advocates is that like EC 1382/2003, ACTA will jeopardize shipments of affordable medicines in transit between developing countries, having a chilling effect on the trade of generic pharmaceuticals and on the TRIPS Agreement flexibilities.^lxxxi This problem has been mostly raised with regard to proposed border measures granting customs officials the ability to restrict shipments being imported or exported from ACTA member countries. This measure has been highly criticized for essentially requiring customs officials to make highly specialized and technical determinations as to what amounts to patent infringements.^lxxxii These complex adjudications, critics say, should follow after the presentation of highly specific facts related to patents, which may only be resolved by an appropriate panel or tribunal post hoc, not while the goods are in transit.^lxxxiii

Under existing TRIPS provisions, border measures are to be taken only against suspected counterfeit, trademark, and copyright violations.^lxxxiv Customs officials are allowed to take ex officio action against alleged infringers only after they have acquired prima facie evidence showing that an IP right has been infringed.^lxxxv In addition, TRIPS requires those who requested the ex officio action to pay for any injury caused to suspected infringers as a result of a wrongful detention of goods.^lxxxvi ACTA, on the other hand, permits such actions to be taken on the mere suspicion that the goods are infringing not only copyright and trademark, but also patent rights. Furthermore, ACTA indemnifies authorities from any injury caused by the wrongful detention of goods, which may last for up to a year under this new agreement.^lxxxvii This creates incentives for right holders to abuse ACTA procedures and to initiate border investigations and seizures without having to prove, within any reasonable period of time, that the goods are in fact infringing. This leaves serious implications relating to the transit of shipments carrying generic medication.

In addition, provisions addressing penalties for ACTA violations vis-à-vis the penalties enforced under the TRIPS Agreement have similarly raised serious concerns.^lxxxviii Under the TRIPS Agreement, any willful, commercial-scale counterfeiting is a criminal act sanctioned by national law enforcement.^lxxxix In contrast, civil IP infringements under TRIPS, including violations of patent rights, consist of commercial disputes between legitimate entities and are compensable only through legal remedies.^xc The reason for this distinction is that unlike counterfeiting, civil infringements of IPRs are not seen as attempts to defraud the public and are therefore not subject to the same criminal sanctions.^xci While TRIPS has made it clear what types of infringements will result in criminal and civil liability, ACTA does not distinguish between the two.^xcii This leaves the inference that because ACTA explicitly targets counterfeits, all infringements will be punishable as criminal violations.

Furthermore, various ACTA drafts have included provisions extending injunctions against third parties who have provided “intermediary services” that have facilitated the infringement involved.^xciii While ACTA fails to define what an “intermediary party” is, those who would likely be affected under this provision include generic drug manufacturers, international shippers, and other key players involved in the international trade of medicines.^xciv In turn, such injunctions could potentially “inhibit the supply and distribution systems and thereby deter generic entry, robust generic competition, and legitimate international trade of generic medicines of assured quality.”^xcv Due to its failure to define “intermediary,” this provision may similarly jeopardize non-government organizations such as Medicins Sans Frontieres and UNITAID, who assist in funding the purchase of generic drugs destined for developing countries.^xcvi

The unfortunate result of these ACTA provisions is that they have a potentially chilling effect on the production, trade, and ultimate distribution of generic drugs. Due to the risk of incurring not only civil, but criminal liability, many generic drug manufacturers and third-party carriers will potentially be deterred from producing and transporting medication because of the blurred distinctions between counterfeit and simple patent infringements.

B. New IP Law-Making in the Process?

A number of scholars have argued that ACTA is an effort to seek an alternative forum that is more responsive to higher levels of IP protection.^xcvii As part of this forum-shifting argument, Susan Sell notes that protectionists have previously shifted their agenda from the World Intellectual Property Organization (“WIPO”) to the World Trade Organization (through the TRIPS Agreement), to bilateral and regional trade agreements (such as those discussed above), and now to ACTA.^xcviii Each time the chosen forum becomes more receptive to exceptions, likely due to pressure from civil society groups, the forum once again changes. Thus, ACTA is seen as the creation of an entirely new international institution for IP enforcement, establishing its own set of rules, standards, and methods of enforcement, notwithstanding those outlined in prior multilateral negotiations such as the TRIPS Agreement.

However, other scholars argue that ACTA is more than a mere effort aimed at shifting the forum of protection. Instead, they assert that such attempts reflect a broader notion of international IP law-making in the process.^xcix This argument is based on the impact which bilateral trade agreements tend to have on a country’s position on IP standards during subsequent multilateral negotiations. These scholars argue that this is all part of a strategy to create an endless upward spiral of international IP obligations.^c This movement, often referred to as the “global IP ratchet,” is only the first stage of a conscious effort on the part of IP interest groups to use bilateral agreements as vehicles to incorporate heightened IP standards into subsequent multilateral treaties, such as ACTA.^ci Targeting countries on a one-on-one basis through bilateral agreements ensures that they are on-board with future stated agendas. Scholars argue that in the end, if enough of these bilateral agreements are negotiated, these higher IP standards will become the minimum standards from which future trade negotiations will proceed.^cii As cited by Kimberlee Weatherall:

“Once a substantial portion of trading partners have agreed to observe the same standards as those enshrined in present U.S./EU legislation, there is no way back to a meaningful lessening of what appear as widely accepted rules, creating a spiral endlessly moving upwards.” ^ciii

That is to say, that all of this is not merely about shifting the forum away from the WTO, but rather, a part of an overall scheme to slowly, but certainly, increase global levels of protection for IP right holders. Weatherall suggests that bilateral agreements have ultimately served as the “stepping stones” for ACTA by setting minimum standards of IP protection among the parties involved, while creating leverage for certain countries at the negotiating table.^civ As reflected by the leaked ACTA drafts, these higher levels of IP protection were, without a doubt, introduced during the various rounds of negotiation.^cv

Along these lines, ACTA is seen as part of a larger “enforcement agenda” being pushed by special interest groups within highly industrialized nations. This enforcement agenda has been described as, “[A] continuous, wide-ranging effort by special-interest groups and lobbyists to secure favorable legislation and institutionalize practices that support their current business models, all under the claim of enforcing intellectual property rights.”^cvi Ultimately, what emerges is “[A] web of numerous forums, regional, and bilateral agreements and unilateral institutions, all being captured to pursue a global TRIPS-plus agenda.”^cvii The unfortunate consequence of this agenda is that because it caters to special interest groups, it fails to consider the disproportionate impact that these higher standards carry for developing countries lacking the resources and infrastructure to implement them. Nonetheless, many fear that such standards will soon become the norm as more and more countries continue to adopt them through efforts such as ACTA.^cviii

IV. ACTA’s Unofficial Drafting History: Establishing An Intent to Promote Access to Medicine

Despite the concerns stated above, recent leaked drafts of the text have indicated that ACTA has amended some of the measures that have been stirring controversy with access to medicine advocates.^cix The two most significant of these are provisions on border measures and intermediary liability.^cx According to the new draft, ACTA no longer requires countries to provide preemptive border measures for patents, meaning that if adopted, generic medicines will no longer be subject to border detentions for alleged patent violations.^cxi In addition to this, ACTA parties have dropped the provision requiring intermediary liability for carriers of shipments of generic medication. The new draft reflects that the parties have made significant concessions in response to public health concerns, resulting in what some have referred to as “ACTA-Lite,” a watered down version of what ACTA was intended to be.^cxii

Aside from demonstrating the tremendous impact that civil society groups can bring to the negotiating table, this move indicates that there is at least some commitment to preserve the safeguards and flexibilities established by the TRIPS Agreement. To demonstrate this commitment, many governments have released public statements ensuring that the passage of ACTA will not affect a country’s right to provide for the public health of its citizens.^cxiii In a joint statement issued by the participating governments with respect to the potential obstruction to access to medication, the parties stated that, “ACTA will not hinder the cross-border transit of legitimate generic medicines,” while reaffirming that “patents will not be covered in the section on Border Measures.”^cxiv

USTR officials released similar statements after certain members of Congress voiced concern over the ways in which ACTA would affect the availability of generic medicine. In a letter from Senator Ron Wyden to the USTR regarding ACTA’s impact, one of his main questions involved the ways in which ACTA would preserve the public health flexibilities under the TRIPS Agreement and the Doha Declaration.^cxv In its response, the USTR stated that “ACTA is not intended to interfere with a signatory’s ability to respect its citizens’ fundamental rights and civil liberties, and will be consistent with the WTO TRIPS Agreement and will respect the Declaration on TRIPS and Public Health. (emphasis added).”^cxvi From these comments, it would therefore appear that the overall purpose of ACTA is not to limit the transit, sale, or distribution of generic medicine. Nonetheless, while this intent has been reflected through a number of press releases, likely aimed at bolstering public support, there is no record of negotiation binding the parties to this intent.

The importance of legislative history within the context of multilateral negotiations is that it establishes the parties’ intent at the time of negotiation, giving the text meaning in light of potential ambiguity. However, in the case of ACTA, there is no such record of negotiations as these have been highly secretive and mostly held behind closed doors.^cxvii As a result, the only evidence of the parties’ actual negotiating intent comes from inferences that have been drawn from the modifications made to several leaked versions of the agreement.^cxviii This paper suggests that based on these modifications, there be an unofficial “drafting history” established, reflecting a principle of intent aimed at upholding access to medicine. This legislative history would be a compilation of the parties’ stated objectives to the press, civil society, members of Congress and Parliament, and other government officials regarding the purpose of ACTA. These statements should be analyzed with respect to the various proposals for modification made by each respective party, as reflected by the leaked versions of the agreement. Furthermore, such a drafting history will require close scrutiny of prior versions of the text in comparison with its final version (to be released in the following weeks) in order to determine whether the parties did in fact bind themselves to their publicly stated objectives. Such an analysis will also allow scholars to draw inferences from the various amendments proposed and those that were actually adopted, such as the changes to border measures discussed above. Functionally, this drafting history will serve to provide guidance to officials whenever there may be ambiguity in the text, by establishing a principle that such ambiguity shall be read in light of the parties’ intent to provide for the unrestricted transit of generic medication.

V. CONCLUSION

Due to legitimate concerns that ACTA may be creating a new institutional framework of IP standards, it is vital that parties clearly define the limits of this new agreement. As we have seen with the cases of EU detentions, there is a genuine fear that heightened IP standards may have serious restrictions on the transit and ultimate distribution of generic medication within developing countries. For this reason, there is a need to clearly and effectively communicate that parties do not intend for this to be the case with the implementation of ACTA. Through publicly released statements, leaked drafts, and new amendments made to the agreement, it appears that the parties to ACTA have made active efforts to communicate that they do not intend to impede the flow of generic medication. However, there is still a need to bind parties to this principle through a more formal manifestation of this commitment.

i Global Health Council, Impact of Infectious Diseases. Available from: http://www.globalhealth.org/infectious_diseases (citing World Health Organization, WHO Global Burden of Disease: 2004 Update).

ii World Health Organization, Global Summary of Aids Epidemic: 2009. Available from: http://www.who.int/hiv/data/2009_global_summary.png.

iii Medicines Sans Frontiers, Running In Place: Too Many Patients Still in Urgent Need of HIV/AIDS Treatment, Briefing Document on HIV/AIDS. Available from: http://www.msfaccess.org/main/hiv-aids/introduction-to-hivaids/msf-and-hivaids.

iv See Generally, Bryan C. Mercurio, TRIPS, Patents, and Access to Life-Saving Drugs in the Developing World, Marquette Intellectual Property Law Review 211 (Summer 2004).

v Id.

vi Id.

vii Id.

viii Id.

ix Oxfam Briefing Paper, Patents versus Patients: Five Years after the Doha Declaration, Oxfam International (November 2006).

x Id.

xi Id.

xii See Generally, Andrew Rens, Collateral Damage: The Impact of ACTA and the Enforcement Agenda on the World’s Poorest People. PIJIP Research Paper No. 2010-08, Program on Information Justice and Intellectual Property (2010).

xiii Susan Sell, Trips and the Access to Medicine Campaign, Wisconsin International Law Journal 481, 484 (2001-2002).

xiv Id.

xv Id.

xvi Id. at 485.

xvii Id. at 487, 488.

xviii Id. at 489.

xix Id. (noting that the US often used access to its large domestic market as a means to force other countries to adopt and enforce stricter intellectual property policies).

xx Daniel Gervais, Intellectual Property, Trade & Development: The State of Play, Fordham Law Review 505, 507 (2005).

xxi Id. at 509.

xxii Trade Related Aspects of Intellectual Property Rights Agreement (1994), available at http://www.wto.org/english/tratop_e/trips_e/t_agm0_e.htm.

xxiii Bryan C. Mercurio, supra note 4, at 218.

xxiv Oxfam Briefing Paper, supra at note 9, at 5.

xxv Id.

xxvi Id.

xxvii Id.

xxviii Id. A compulsory license is a type of flexibility provided by the TRIPS Agreement, stating that countries may grant drug manufacturers the authorization to produce the generic version of a patented drug without the consent of the right holder in order to meet a public health emergency.

xxix Id.

xxx Bryan C. Mercurio, supra note 4, at 224.

xxxi Id.

xxxii Doha Declaration on the TRIPS Agreement and Public Health (2001), available at http://www.wto.org/english/thewto_e/minist_e/min01_e/mindecl_trips_e.htm.

xxxiii Id.

xxxiv Rahul Rajkumar, The Central American Free Trade Agreement: An End Run Around the Doha Declaration on TRIPS and Public Health, Albany Law Journal of Science and Technology 433, 441 (2005) (citing Doha Declaration).

xxxv Id.

xxxvi Agreement on the Trade Related Aspects of Intellectual Property Rights (1995).

xxxvii Rahul Rajkumar, supra note 35, at 444.

xxxviii Id.

xxxix Agreement on the Trade Related Aspects of Intellectual Property Rights (1995).

xl Oxfam Briefing Paper, supra note 9, at 9.

xli Id.

xlii Id. at 10.

xliii Id. (explaining the case in Brazil in 2005 after it threatened to issue a compulsory license, causing a 46% discount in the price of Kaletra, an anti-retroviral AIDS drug).

xliv See e.g., Medicine Sans Frontieres, available at http://www.msf.org.

xlv See Generally Bryan C. Mercurio, supra note 4.

xlvi Sisule F. Musung et al., The Use of Flexibilities in TRIPS by Developing Countries : Can They Promote Access to Medicine?, Study 4C, Commission on Intellectual Property Rights, Innovation and Public Health (August 2005).

xlvii Id.

xlviii Oxfam Briefing Paper, supra note 9, at 13.

xlix Id. (citing as an example, the US-Jordan free trade agreement).

l Id. at 15.

li Report of Committee on Government Reform, Trade Agreements and Access toMedicine Under the Bush Administration (June 2005).

lii Jorn Sonderholm, Intellectual Property Rights and the TRIPS Agreement: An Overview of Ethical Problems and Some Proposed Solutions, Policy Research Working Paper No. 5228, World Bank Development Research Group (March 2010).

liii Oxfam Briefing Paper, supra note 9, at 13. (USTR declaring an internal reorganization plan to “better support vital US innovation, including those of the pharmaceutical industry”).

liv Id. (noting that there are currently 20 pharmaceutical-industry representatives on USTR advisory committees).

lv 19 U.S.C. § 2411 (1974).

lvi Id.

lvii Oxfam Briefing Paper, supra note 9, 1t 14. (noting that this applies despite the fact that countries may be in compliance with minimum IPR standards required by the TRIPS Agreement).

lviii Id. at 17.

lix Government Accountability Office Report, supra note 60.

lx Id.

lxi Id.

lxii Id. at 41. (noting that several pending free trade agreements have been amended and made more responsive to provisions outlining TRIPS flexibilities).

lxiii Id.

lxiv Xavier Seuba, Free Trade of Pharmaceutical Products: The Limits of Intellectual Property Enforcement at the Border, International Centre for Trade and Sustainable Development, Issue Paper No. 27, 9 (2010).

lxv Council of Regulation (EC) No. 1383/2003 of 22 July 2003.

lxvi Id.

lxvii Xavier Seuba, supra note 65.

lxviii General Agreement on Tariffs and Trade (1947).

lxix Xavier Seuba, supra note 65, at 2.

lxx Id. at 5.

lxxi Id.

lxxii Id.

lxxiii Id.

lxxiv Negotiating countries include the US, the EU, Japan, Mexico, Switzerland, Australia, NZ, South Korea, Morocco, Singapore, and Canada

lxxv United States Trade Representative, ACTA Fact Sheet (March 2010), available at http://www.ustr.gov/acta-fact-sheet-march-2010.

lxxvi Id.

lxxvii ICTSD, Animated TRIPS Council Meeting Tackles Public Health, ACTA, Biodiversity, Intellectual Property Programme, Vol. 14:22 (June 16, 2010).

lxxviii Id.

lxxix ICTSD, ACTA Faces Criticism at WTO and in the United States, Bridges Weekly Trade News Digest, at 8, Vol. 14:38 (Nov. 3, 2010).

lxxx Id.

lxxxi Peter Mayberduk, ACTA and Public Health, PIJIP Research Paper No. 2010-09, Program on Information Justice and Intellectual Property (2010).

lxxxii Id. at 2.

lxxxiii Id.

lxxxiv Id. (citing Trade Related Aspects of Intellectual Property Rights Agreement (1994)).

lxxxv Id. (citing TRIPS Article 48).

lxxxvi Id.

lxxxvii Peter Mayberduk, supra note 82, at 3.

lxxxviii Id. at 5.

lxxxix Id.

xc Id. (These remedies include monetary damages, injunctions, and declaratory relief).

xci Id.

xcii Id.

xciii Anti-Counterfeiting Trade Agreement (August 2010).

xciv Brook K. Baker, ACTA: Risks of Intermediary Liability for Access to Medicine, Program on Information Justice and Intellectual Property, PIJIP Research Paper No. 2010-01.

xcv Id.

xcvi Id.

xcvii See Generally, Peter K. Yu, Six Secret (and Now Open) Fears of ACTA (June 14, 2010). SMU Law Review, Vol. 64, 2011.

xcviii Susan K. Sell, The Global IP Upward Ratched, Anti-Counterfeiting and Piracy Enforcement Efforts: The State of Play, IQsensato Occasional Papers No. 1 (June 2008) (stating that, “As soon as one venue becomes less responsive to a high protectionist agenda, IP protectionists shift to another In search of a more hospitable venue.”).

xcix Kimberlee Weatherall, ACTA as a New Knd of International IP Law-Making, PIJIP Paper No. 2010-12, Program on Information Justice and Intellectual Property (2010).

c Id.

ci Id. at 6. (noting that several of the countries participating in ACTA negotiations are parties to a U.S. free trade agreement (either active or pending Congressional approval) and that the negotiating position of these countries has been influenced by their respective FTA with the US).

cii Id.

ciii Id. at 9.

civ Id. at 6.

cv Anti-Counterfeiting Trade Agreement (August 2010).

cvi Peter Mayberduk, supra note 82 (arguing that the key players behind this agenda are multinational tobacco, pharmaceutical, film and record companies, noting that these are the primary lobbying bodies behind the advancement of ACTA).

cvii Andrew Rens, supra note 12.

cviii Id.

cix ICTSD, Watered-down ACTA Approaching Conclusion, Bridges Weekly Trade News Digest, Vol. 14:30 (September 8, 2010)

cx Anti-Counterfeiting Trade Agreement (October 2010).

cxi Id.

cxii ICTSD, Watered-down ACTA Approaching Conclusion, supra note 110.

cxiii ICTSD, Officials Seek to Ease Fears of Privacy Violations under ACTA, Bridges Weekly Trade News Digest, Vol. 14: 25 (July 7th 2010).

cxiv Id.

cxv Letter from Ron Wyden to USTR, January 6, 2010, available at http://www.ustr.gov/webfm_send/1701.

cxvi Response from USTR to letter from Senator Ron Wyden, January 28, 2010, available at http://www.ustr.gov/webfm_send/1700.

cxvii See generally, Over 75 Law Profs Call for Halt of ACTA, available at http://www.wcl.american.edu/pijip/go/blog-post/academic-sign-on-letter-to-obama-on-acta (accessed November 22, 2010).

cxviii See generally, ACTA- Text and Leaked Documents, PIJIP Database, available at https://sites.google.com/site/iipenforcement/acta (accessed November 22, 2010).

The "Initial Interest Confusion" Test – Analysis and Proposal for a Sensible Formulation for Use on the Internet

The National Law Review is proud to announce that Jaclyn Coronado Sitjar of Saint Louis University School of Law is one of our Student Legal Writing Contest Winners for March of 2011. Jaclyn’s article focuses on the element of likelihood of consumer confusion which is the crux of many trademark infringement claims.

Introduction

The Internet facilitates online commerce and provides a wealth of information to consumers by allowing users to search for a product or brand and to receive results, suggestions, and advertisements. Internet consumers using search engines are familiar with search-based advertising, where advertisements appear next to search results. Google provides an advertising service, AdWords.[i]AdWords allows advertisers to bid on search terms, called keywords, and then Google links those keywords to the advertiser’s advertisements or hyperlinks.[ii]When an Internet consumer searches for the keyword the advertiser purchased, the sponsored link or advertisement is triggered and appears either above or to the right of the organic search results.[iii] Other search engines including Netscape and Excite use programs similar to Google AdWords to allow advertisers to either bid for or purchase specific search terms.[iv]

During the first half of 2010, U.S. Internet advertising revenue broke a new half-year record with U.S. Internet advertisers spending $12.1 billion.[v] The average American spends more than sixty hours a month online and 55% of American adults use the Internet daily.[vi] With increasing Internet advertising and use, the possibility of consumer confusion exists on the Internet. Advertisers can buy keywords related to their line of business, which may include buying a competitor’s trademark. For example, if Advertiser A buys Competitor B’s trademark as a keyword, then an Internet search for Competitor B’s product will trigger Advertiser A’s ads in a list of sponsored links along the search results. This example presents a possibility of consumer confusion on the Internet.[vii] One way to alleviate Internet consumer confusion is through the court’s regulation of trademarks in metatags, domain names, and keyword-sponsored advertising and the adoption of the initial interest doctrine.[viii]

I. Background Information

The Lanham Act of 1946 federally regulates trademarks by creating a registration system for marks used in U.S. commerce and providing causes of action for the infringement of both registered and unregistered marks.[ix] Under the Lanham Act, a trademark is “any word, name, symbol, or device, or any combination thereof . . . to identify and distinguish his or her goods, including a unique product, from those manufactured or sold by others and to indicate the source of the goods.”[x]Trademark law serves two primary purposes: (1) to protect the trademark owner’s private interests of the resources and efforts invested into establishing trademarks and (2) to protect the public by reducing the likelihood of consumer confusion by prohibiting misleading trademark practices.[xi]

Section 43 of the Lanham Act defines trademark infringement of unregistered trademarks, which is a cause of action allowing trademark owners the right to bring a civil suit against anyone who “uses” another’s trademark “in commerce” when such use is likely to confuse or deceive consumers in advertising or promotion.[xii] Section 32 of the Lanham Act is the provision for trademark infringement of a registered trademark.[xiii] Although the Lanham Act provides for protection against infringement of both registered and unregistered marks, courts and litigants tend to look to Section 43, which also protects unfair methods of competition, e.g. false designation of origin, sponsorship, or approval.[xiv] Courts interpret both Section 32 and Section 43 to require a plaintiff to establish three elements for a successful trademark infringement action.[xv] First, the plaintiff shows a valid trademark entitled to protection under the Lanham Act.[xvi] Second, the plaintiff shows the defendant used the plaintiff’s mark or a similar mark in commerce.[xvii] Third, the plaintiff must prove the defendant’s use will create a likelihood of confusion.[xviii]

A. Use in Commerce

At issue in many online trademark infringement cases is the second element of the infringement analysis, use in commerce.[xix] The Lanham Act defines “use in commerce” as the bona fide use of a mark either on goods or services.[xx] In the offline context, selling a product with another’s trademark affixed to the carton is an example of sufficient use in commerce.[xxi] In the online context without tangible products to affix trademarks to, courts have had to determine Internet-specific issues such as whether domain names including competitor trademarks or using metatags of a competitor’s trademark constitute sufficient use in commerce.[xxii]With the rise in search-based advertising,[xxiii] the most recent issue with online use in commerce is buying and selling trademarks as keywords. In Rescuecom Corp v. Google Inc., the Second Circuit Court of Appeals recently ruled that buying another’s trademark through Google’s advertising service AdWords constitutes use in commerce.[xxiv] Rescuecom aligned the Second Circuit with the majority of other circuits finding that a defendant’s use of plaintiff’s trademarks to trigger keyword advertising is sufficient use in commerce.[xxv]

B. Likelihood of Confusion

The final element, likelihood of consumer confusion, forms the crux of most trademark infringement claims.[xxvi] Courts employ a multifactor test to determine the likelihood of confusion by applying a version of the eight factors established by the Ninth Circuit in AMF, Inc. v. Sleekcraft Boats:

(1) similarity of the conflicting marks; (2) proximity of the two companies’ products or services; (3) strength of the plaintiff’s mark; (4) marketing channels used by the two companies; (5) degree of care likely to be exercised by purchasers in selecting goods; (6) defendant’s intent when selecting the mark; (7) evidence of actual consumer confusion; and (8) likelihood of expansion of product lines.[xxvii]

The multifactor test is flexible and other circuits may apply fewer or more factors.[xxviii] Whatever factors a court employs, the ultimate test focuses on whether defendant’s use is likely to confuse or deceive customers into thinking there is some sponsorship between the trademark owner and the infringing mark.[xxix]

Usually courts determine likelihood of confusion at the time the consumer makes the purchase. However, sometimes circumstances arise where the consumer is actually confused before making the purchase. For example, an Internet consumer may only be confused into visiting a website, not into actually purchasing a product. A consumer could click on an ad triggered by a keyword containing the competitor’s trademark. Since the traditional likelihood of confusion standard does not translate well to such keyword cases, some courts have turned to initial interest confusion.

II. Initial Interest Confusion

A. Introduction to Initial Interest Confusion

Initial interest confusion is the temporary, pre-sale confusion that occurs when a consumer is drawn to a product believing it to be affiliated with another company because the product somehow evokes that company’s trademark.[xxx] Initial interest confusion is a judicially created doctrine applied where a product generates initial customer interest by using another’s trademark, even if the customer never actually buys the infringing product.[xxxi] Courts applying initial interest confusion can hold defendants liable based on an unfair “bait-and-switch theory” for practices that “affect the buying decisions of consumers in the market for the goods, effectively allowing the competitor to get its foot in the door by confusing consumers.”[xxxii]

The Second Circuit first developed initial interest confusion in 1975 in Grotrian v. Steinway & Sons after finding the traditional likelihood of confusion analysis insufficient to hold the culpable defendants liable.[xxxiii] In Grotrian, a German corporation sold pianos under the trade name “Grotrian-Steinweg” which competed with the well-known piano manufacturer Steinway & Sons.[xxxiv] The district court applied the traditional likelihood of confusion test with special focus on the “degree of likely consumer care” factor.[xxxv] Although expensive piano consumers have a high sophistication level, this sophistication did not eliminate the possibility of consumer confusion between the similar marks.[xxxvi] The court coined the initial interest confusion theory by noting that a potential Steinway buyer might initially be misled to the less expensive Grotrian-Steinweg, which injures Steinway.[xxxvii] The issue was “not the possibility that a purchaser would buy a Grotrian-Steinweg thinking it was actually a Steinway, but rather that, by virtue of “initial confusion,” the “‘Grotrian-Steinweg’ name … would attract potential customers based on the reputation built up by Steinway in this country for many years.”[xxxviii] The consumer’s confusion occurred before the purchase when a consumer would initially afford Grotrian-Steinweg pianos positive credibility because of the consumer’s mental association with the Steinway & Sons mark, regardless of whether the consumer actually purchased a Grotrian-Steinweg piano or not.[xxxix] Therefore, the Second Circuit found the absence of point-of-sale confusion was irrelevant because harm resulted from the initial interest confusion.[xl]

The Second Circuit used the same rationale twelve years later in Mobil Oil Corp. v. Pegasus Petroleum Corp., holding defendant’s “Pegasus Petroleum” name for an oil trading company infringed on plaintiff’s trademarked flying horse logo.[xli] There was a likelihood of confusion “not in the fact that a third party would do business with Pegasus Petroleum believing it was related to Mobil, but rather in the likelihood that Pegasus Petroleum would gain crucial credibility during the initial phases of a deal.”[xlii]

Since Grotrian and Mobil, other circuits have applied initial interest confusion to trademark infringement cases.[xliii] With the rise of the Internet, courts also apply initial interest confusion in the online context.[xliv] The landmark case on online initial interest confusion is Brookfield Communications, Inc. v. West Coast Entertainment Corp.[xlv] Plaintiff Brookfield Communications offered an Internet software database of the entertainment industry using the trademark “MovieBuff.”[xlvi] Brookfield claimed trademark infringement against defendant West Coast’s use of the domain name “moviebuff.com” and the term “MovieBuff’ in metatags for its own entertainment industry database.[xlvii] Metatags are lines of code in a website’s Hyper Text Mark-Up Language (HTML) invisible to the internet user that older search engine technologies used to compile and order search results lists.[xlviii] The Ninth Circuit held for Brookfield, finding initial interest confusion is likely to result from West Coast Entertainment’s metatag use.[xlix]Internet users searching for Brookfield’s MovieBuff product may discover West Coast’s website and, finding a free database similar to Brookfield’s product, the user may “simply decide to utilize West Coast’s offerings instead.”[l] This is actionable initial interest confusion “in the sense that, by using ‘moviebuff.com’ or ‘MovieBuff’ to divert people looking for ‘MovieBuff’ to its website, West Coast improperly benefits from the goodwill that Brookfield developed in its mark.”[li]

B. Criticism and Proposal for Courts Applying Initial Interest Confusion

Brookfieldwas a controversial decision that has been criticized by scholars and judges.[lii] In reaching its conclusion, the Ninth Circuit did not employ the eight-factor Sleekcraft test.[liii] Instead, the court stated “the traditional eight-factor test is not well-suited for analyzing the metatags issue,” then considered only whether the metatags caused initial interest confusion.[liv] This departure from the likelihood of confusion test sparked criticism over whether initial interest confusion is a viable theory to find trademark infringement liability.[lv]

Another criticism is that unlike the earlier offline cases ofGrotrian and Mobilinvolving both the presence of confusion and the misappropriation of goodwill in famous marks[lvi], Brookfield found initial interest confusion merely on the potential that West Coast might receive some benefit from Brookfield’s mark.[lvii]Another common criticism of initial interest confusion is there is no real economic justification for its application, especially online where there is only a de minimiscost to consumers to click back and forth between websites.[lviii] However, because the internet affords a plethora of advertising techniques ranging from metatags to keyword advertising, the online consumer may actually be confused more often than the offline consumer.[lix] Furthermore, Rescuecom shows that with courts in agreement that using trademarks in these contexts is actionable trademark use, infringement claims will survive summary judgment, urging some standard of uniformity among courts applying initial interest confusion.[lx]

In response to this criticism, the Second, Third, Sixth, Seventh, Ninth and Tenth Circuits have recognized online initial interest confusion.[lxi] Just as courts apply different variations of the likelihood of consumer confusion tests,[lxii] courts are also applying different variations of initial interest confusion analysis.[lxiii] Circuit courts and district courts within these circuits are even applying different variations of initial interest confusion.[lxiv] This paper organizes the conundrum of initial interest confusion by three different approaches used by the courts: (1) Engaging in the entire traditional likelihood of confusion analysis and then considering initial interest confusion as a separate factor, (2) Only considering initial interest confusion or giving undue weight to diversion, and (3) Analyzing initial interest confusion within the “evidence of actual confusion” factor or “customer care” factor.

1. Courts analyzing initial interest confusion separately before or after the traditional likelihood of confusion test

Courts in the Second, Third, Sixth and Ninth Circuits analyze initial interest confusion separately from the traditional likelihood of confusion analysis.[lxv] These courts either assess initial interest confusion before or after the traditional likelihood of confusion factors. In the Second Circuit, Savin Corp. v. The Savin Group involved a domain name dispute.[lxvi] The Polaroid factors are the eight factors that the Second Circuit applies to determine whether there is a likelihood of confusion in a trademark infringement case.[lxvii] The Savin court considered initial interest confusion separately after the Polaroid analysis because it “does not fall neatly under any of the Polaroid factors.”[lxviii] The Savin court relied on precedent in Bihari v. Gross, which required a showing of intentional deception before finding initial interest confusion.[lxix] Because the plaintiff had failed to raise a triable issue of fact on either a likelihood of confusion or intentional deception, the Second Circuit affirmed the district court’s summary judgment to the defendant.[lxx]

In Checkpoint Systems, Inc. v. Check Point Software Technologies, Inc., the Third Circuit assesses all ten Lapp factors and then analyzes initial interest confusion.[lxxi] The Lapp factors are the Third Circuit’s ten factors used to determine likelihood of confusion in trademark infringement cases.[lxxii] Furthermore, all Lapp factors should be considered whether a plaintiff alleges initial interest confusion, point-of-sale confusion, or both.[lxxiii] Two district courts in the Third Circuit addressed initial interest confusion in keyword advertising cases with the District Court of New Jersey following Checkpoint and the Eastern District of Pennsylvania deviating from Checkpoint.[lxxiv] The District Court of New Jersey in 800-Jr Cigar, Inc. v. Goto.com, Inc. followed Checkpoint by applying all ten Lapp factors and then engaged in a more comprehensive initial interest confusion analysis. [lxxv] The court looked at (1) product relatedness, (2) the level of care exercised by consumers in making purchasing decisions, (3) the sophistication of the purchaser/consumer; and (4) the intent of the alleged infringer in adopting the mark.[lxxvi] The court ultimately found genuine issues of material fact in four of the ten Lapp factors and the impact, if any, of initial interest confusion and denied both parties’ motions for summary judgment.[lxxvii]

Conversely, the court for the Eastern District of Pennsylvania in the Third Circuit declined to extend initial interest confusion in keyword advertising in JG Wentworth v. Settlement Funding LLC.[lxxviii] JG Wentworth alleged Settlement Funding LLC’s purchase of the keyword “JG Wentworth” from Google AdWords for sponsored link advertisements and using JG Wentworth’s trademarks as metatags in Settlement Funding LLC’s websites caused initial interest confusion.[lxxix] Instead of applying the Lapp factors, the court hastily decided there was no likelihood of confusion and no trademark infringement because Settlement Funding LLC’s website link was “separate and distinct” from JG Wentworth’s website link, therefore eliminating potential consumers from the “opportunity to confuse defendant’s services, goods, advertisements, links or websites for those of JG Wentworth’s.”[lxxx]

Since Brookfield, the Ninth Circuit has encountered a variety of cases alleging initial interest confusion on the Internet.[lxxxi] In the Internet context, the Ninth Circuit has applied its Sleekcraft factors before addressing initial interest confusion in trademark infringement cases involving a domain name, keyword advertising, and most recently with Google’s AdWords program.[lxxxii] However, the Ninth Circuit has also held that in the Internet context, the three most importantSleekcraft factors are (1) the similarity of the marks, (2) the relatedness of the goods or services, and (3) the parties’ simultaneous use of the Web as a marketing channel.[lxxxiii] These three factors have been dubbed the “controlling troika” or the “internet trinity.”[lxxxiv] When the Internet trinity factors suggest likely confusion, the other factors must “weigh strongly” against a likelihood of confusion to avoid finding infringement.[lxxxv]

For example, in Interstellar Starship Services, Ltd. v. Epix, Inc., the plaintiff alleged that the defendant’s domain name caused a likelihood of initial interest confusion.[lxxxvi] The Ninth Circuit affirmed the district court’s holding of no likelihood of initial interest confusion, explicitly stating that the district court correctly applied all Sleekcraft factors instead of just the internet trinity factors.[lxxxvii] However, courts have interpreted Interstellar to engage in a type of burden-shifting analysis between the internet trinity factors and the rest of theSleekcraft factors.[lxxxviii] After finding the internet trinity factors favor a plaintiff, the burden shifts to the defendant to prove the remaining factors “weigh strongly against a likelihood of confusion.”[lxxxix] This was seen in Perfumebay.com Inc. v. eBay Inc. with Perfumebay.com seeking declaratory judgment that its various forms of the mark “Perfumebay” did not infringe eBay’s trademark.[xc] The Ninth Circuit affirmed the district court’s holding that a likelihood of consumer confusion and initial interest confusion existed.[xci] There was a likelihood of consumer confusion because the trinity factors (strong similarity between the marks “Perfumebay” and “eBay,” both parties used the internet as a marketing channel, and both parties sold similar products) weighed strongly in eBay’s favor and the plaintiff could not outweigh this showing with any of the other Sleekcraftfactors.[xcii]

The Sixth Circuit, like the Ninth Circuit, applies the Internet trinity factors and the other remaining five factors from its traditional likelihood of confusion test.[xciii] InPaccar Inc. v. TeleScan Technologies, L.L.C., the trucking company Paccar claimed trademark infringement against TeleScan Technologies, the owner of a used truck locator website, based on Paccar’s trademarks in its domain names and meta tags.[xciv] After the district court granted a preliminary injunction against the defendants, Sixth Circuit affirmed the preliminary injunction due to Paccar’s demonstration of “a likelihood of confusion and, thus, a strong likelihood of success on the merits of its trademark infringement claim.”[xcv] Central to its holding, the court relied on the internet factors of mark similarity, relatedness of goods or services, simultaneous use of the Internet as a marketing channel, without relying much on the other likelihood of confusion factors.[xcvi]

2. Courts analyzing only initial interest confusion or giving undue weight to diversion

Some courts found a likelihood of confusion because of initial interest confusion without engaging in the traditional multi-factor analysis or give undue weight to diversion in finding a likelihood of ocnfusion exists.[xcvii] At least one district court is not applying any of the factors tests and instead is relying solely on the initial interest doctrine.[xcviii] In Morningware, Inc. v. Hearthware Home Products, Inc., the court for the Northern District of Illinois found the plaintiff had sufficiently alleged evidence of initial interest confusion to deny the defendant’s Rule 12(b)(6) Motion to Dismiss.[xcix] The defendant had purchased plaintiff’s trademark and variations of plaintiff’s trademark as a keyword from Google’s AdWords program.[c] In finding a likelihood of confusion, the Morningware court relied on a previous Seventh Circuit ruling in Promatek Indus., Ltd. v. Equitrac Corp.[ci]

Promatek involved analogous facts to Morningware, finding a likelihood of confusion when the defendant used the plaintiff’s trademarks in the defendant’s website metatags.[cii] In Promatek, the Seventh Circuit recognized that initial interest confusion can arise even if consumers who are misled to a website are only briefly confused.[ciii] Under Promatek, “What is important is not the duration of the confusion, it is the misappropriation of Promatek’s goodwill.”[civ] InMorningware, “Hearthware’s advertisement does not mention Hearthware and the consumer who views the Hearthware advertisement searched for the term ‘Morningware,’ the advertisement could mislead consumer to believe that the link is associated with Hearthware.”[cv] Following Promatek, Morningware had sufficiently alleged initial interest confusion.[cvi] In reaching this conclusion, the court did not engage in any likelihood of confusion analysis. The court cited seven factors to assess for the likelihood of consumer confusion, but then spent the rest of the likelihood of confusion discussion only on Promatek.[cvii]

The Tenth Circuit in Australian Gold, Inc. v. Hatfield is an example of a court giving undue weight to diversion.[cviii] Defendant Hatfield sold plaintiff Australian Gold’s (“AG”) tanning products over the internet without AG’s authorization.[cix] Hatfield used AG’s trademarks in website metatags and paid a search engine for search result priority.[cx] The Tenth Circuit affirmed the district court’s finding Hatfield liable for trademark infringement for using AG’s trademark within Hatfield’s metatags.[cxi] The court found that the defendant’s intent in using the marks, similarity of products and manner of marketing, the degree of care consumers were likely to exercise, and mark strength all weighed in plaintiff’s favor.[cxii] However, the court went a step further and found that diversion was inherently damaging even though the plaintiffs did not offer any evidence of actual confusion.[cxiii] The court found that “the original diversion of the prospective customer’s interest to a source that he or she erroneously believes is authorized” is a harm caused by initial interest confusion.[cxiv]

Additionally, the court’s treatment of Hatfield’s website disclaimers bolstered the court’s belief that diversion is inherently damaging. Hatfield’s disclaimers disavowed any connection with plaintiffs and clarified the true source of the website.[cxv] Adhering to its belief that damage had already been done once consumers were diverted to defendant’s websites, the court found defendant’s disclaimers to be irrelevant.[cxvi] The purpose of Hatfield’s disclaimers were to clear up any consumer confusion, but the court found the damage from the original diversion was sufficiently actionable. Australian Gold suggests that diversion is inherently damaging and even absent a defendant’s use of disclaimers or plaintiff’s evidence of actual confusion, the Tenth Circuit will still find actionable trademark infringement based on initial interest confusion.[cxvii]

3. Courts analyzing initial interest confusion within the “evidence of confusion” or “customer care” factor of the traditional likelihood of confusion test

The last formulation is courts analyzing initial interest confusion within the “evidence of confusion” factor or the “customer care” factor. Including this analysis as part of the traditional likelihood of confusion factors adheres to the Lanham Act standard for trademark infringement, “likely to cause confusion.”[cxviii] Subsuming initial interest confusion within the complete factors test also reconciles criticism that initial interest confusion is inappropriately expanding trademark infringement to include diversion.[cxix]

The Fifth Circuit applied initial interest confusion in the “evidence of actual confusion” factor based on witness testimony in Elvis Presley Enterprises, Inc. v. Capece.[cxx] Elvis Presley Enterprises (“EPE”) claimed trademark infringement against Capece for using the service mark “The Velvet Elvis” for his nightclub and for using Elvis Presley’s image and likeness in advertising and promoting.[cxxi] Within its seven-factor analysis, the court discussed initial interest confusion within evidence of actual confusion because customers were lured into “The Velvet Elvis” thinking it was associated with the “Elvis Presley” trademark name.[cxxii] The court reasoned there was initial interest confusion even if the customers realized there was no association with “The Velvet Elvis” and “Elvis Presley” upon entering the nightclub.[cxxiii] According to the court, “Despite the confusion being dissipated, this initial-interest confusion is beneficial to the Defendants because it brings patrons in the door; indeed, it brought at least one of EPE’s witnesses into the bar. Once in the door, the confusion has succeeded because some patrons may stay, despite realizing that the bar has no relationship with EPE.”[cxxiv] The court found this initial interest confusion coupled with actual confusion from Capece’s advertising practices weighed “evidence of actual confusion” in EPE’s favor.[cxxv] Although the Fifth Circuit has not ruled specifically on initial interest confusion and keyword advertising cases, one scholar hypothesizes that based on Elvis Presley Enterprises, Inc., the Fifth Circuit may apply initial interest confusion because a sponsored link advertisement luring online customers into a website based on the use of a trademark is analogous to the luring rationale between “The Velvet Elvis” and “Elvis Presley.”[cxxvi]

As Elvis Presley Enterprises, Inc. found a likelihood of confusion based on both actual confusion and initial interest confusion,[cxxvii] courts have also reached similar conclusions even in the absence of actual confusion.[cxxviii] The Sixth Circuit has even gone so far to state that, “evidence of initial-interest confusion comes into the eight factor Frisch test as a substitute for evidence of actual confusion.”[cxxix] The court for the Southern District of Ohio adopted this approach in Tdata Inc. v. Aircraft Technical Publishers.[cxxx] In Tdata Inc., the plaintiff alleged that the defendant’s website metatags containing plaintiff’s trademarks constituted trademark infringement.[cxxxi] Before applying the eight factor Frischtest, the court decided to apply initial interest confusion, reasoning that, “use of the company’s mark in metatags constitutes infringing use of the mark to pull consumers to Tdata’s website and the products it features, even if the consumers later realize the confusion.”[cxxxii] Instead of just stopping there and concluding a likelihood of confusion, the court went through the eight factor Frisch test.[cxxxiii] The previous finding of initial interest confusion was substituted into the “actual confusion” factor, even without evidence of actual confusion.[cxxxiv] Tdata Inc.exemplifies the benefit of applying all of the factors instead of prematurely resting solely on initial interest confusion. This case also shows that absent actual confusion, a court can properly assess the other factors and find a likelihood of confusion.[cxxxv]

The Second Circuit and the Seventh Circuit have also incorporated initial interest into the “consumer care” factor.[cxxxvi] In Mobil, the Second Circuit affirmed the district court’s finding of initial confusion based on “the probability that potential purchasers would be misled into an initial interest in Pegasus Petroleum.”[cxxxvii] In Promatek, the Seventh Circuit placed importance on consumer care, explicitly stating, “The degree of care exercised by consumers could lead to initial interest confusion,” before finding a likelihood of confusion existed.[cxxxviii]

A recent example of courts including initial interest analysis into the factors test isBabyage.com, Inc. v. Leachco, Inc. from the District Court of the Middle District of Pennsylvania.[cxxxix] BabyAge.com’s baby product website includes “featured brand” manufacturers, including Leachco.[cxl] The “featured brand” webpage displayed Leachco’s trademark and included a section entitled “Pregnancy Pillows.”[cxli] The webpage also contained hyperlinks that would take the viewer to webpages containing non-Leachco products.[cxlii] Leachco argued under a “bait and switch theory” that “prospective customers are ‘baited’ by Leachco’s brand into visiting the Leachco “featured brand” webpage on the Baby-Age Website, baited into pursuing a Leachco pregnancy pillow, and then “switched” to non-Leachco pregnancy pillows by the hyperlinks.[cxliii] The court applied theLapp factors and analyzed initial interest confusion within both the customer care and the actual confusion factors.[cxliv] Under customer care, the court found that low price alone was insufficient to make an appropriate conclusion on the level of customer care.[cxlv] Under actual confusion, Leachco sought more information on point of sale and internet traffic that may be probative of initial interest confusion.[cxlvi] The court ultimately denied Leachco’s motion for summary judgment because more development was needed for the customer care and actual confusion factors.[cxlvii]

III. Criticism of Tests 1 and 2 and Proposal for Courts to Adopt Test 3

A. Criticism of Tests 1 and 2

The strongest argument against Test 1, courts analyzing initial interest confusion separately before or after the traditional likelihood of confusion, is that this approach is inefficient and more time-consuming. Instead, courts should include the initial interest analysis within one of the factors as proposed in Part III(B). Separating the initial interest analysis from the likelihood of confusion factors is also problematic because it could run the risk of turning into the formulation in Part II(B)(2), just applying the initial interest analysis.

Analyzing initial interest confusion as a separate doctrine without engaging in the traditional likelihood of confusion test in Test 2 is problematic because it acts as a shortcut to finding trademark infringement.[cxlviii] Completely discarding the multi-factor test makes it easier for a plaintiff to prove trademark infringement if only initial interest confusion is needed.[cxlix] Lowering the bar for plaintiffs to bring trademark infringement would not only strain the judicial system with increased cases, but would also adversely harm consumers and defendant trademark owners. If trademark owners were more susceptible to trademark infringement cases, they would have to reallocate resources to defend themselves in court. Instead of using resources to improve product quality and create new products, trademark owners would have to resources to defend trademark infringement suits, thereby depriving consumers.

Finding a likelihood of confusion solely on initial interest confusion in the Internet is dangerous and threatens to undermine the purposes of trademark law. For example, a plaintiff could allege initial interest confusion based on diversion resulting from a defendant’s use of the plaintiff’s trademark in keyword advertising or metatags. Suppose plaintiff and defendant compete in completely unrelated markets, have dissimilar marks, and both have high levels of consumer sophistication. Under a traditional likelihood of confusion test, it is unlikely a court would find a likelihood of confusion under these circumstances. However, a court choosing to solely apply initial interest confusion could focus on the defendant’s use of the plaintiff’s mark to divert consumers and find a likelihood of initial interest confusion. Although no cases have gone to this extreme of finding initial interest confusion, some courts are inappropriately expanding the scope of initial interest confusion by giving undue weight to the misappropriation of goodwill.[cl]

Another statutory argument against courts just using initial interest confusion is this formulation conflates the trademark infringement test by using misappropriation of goodwill to satisfy both threshold use and likelihood of confusion.[cli] Such a construction is doctrinally inappropriate because likelihood of confusion, not the misappropriation of goodwill, is the “hallmark” of analyzing trademark infringement.[clii] Conflating the trademark infringement test would make it much easier for plaintiffs to bring trademark infringement cases, which would negatively affect the trademark owners who would have to expend time and resources to defend these cases.

The greatest danger of applying solely initial interest confusion is that this approach disregards the Lanham Act. The Lanham Act does not expressly state that trademark infringement is actionable based on initial interest confusion. Instead, the only analysis within the Lanham Act is the likelihood of confusion test, so therefore the likelihood of confusion doctrine should be the only analysis applied to trademark infringement claims.[cliii] One scholar likened initial interest confusion on the Internet to judicial activism.[cliv] The argument was that since the Lanham Act does not include pre-sale confusion as actionable trademark infringement, courts could erroneously extend initial interest confusion to cover consumers searching on the Internet who become initially confused and interested in a competitor’s product.[clv] Without the traditional likelihood of confusion factors test, courts could just apply initial interest confusion to almost any alleged defendant’s use of a sponsored link advertisement, which would frustrate consumers’ intent and interest.[clvi]

As this section demonstrates, courts should not base a finding of consumer confusion solely on initial interest confusion because this formulation contravenes the trademark goals of protecting the trademark owner’s interests and benefiting consumers.

B. Proposal for Test 3

The District Court of the Middle District of Pennsylvania in Babyage.com, Inc.demonstrates a trend in the right direction of courts applying initial interest confusion within the factors test. For the reasons stated above, courts should continue to apply the traditional likelihood of confusion factors and incorporate initial interest confusion within either the “evidence of actual confusion” or “customer care” factors. Analyzing initial interest confusion within the likelihood of confusion test has already garnered support from some courts and scholars and the remaining courts should follow.[clvii]

This approach is preferable for three reasons: (1) Maintaining the Lanham Act standard for finding a likelihood of confusion instead of giving undue weight to diversion, (2) Serving trademark goals of protecting trademark owner’s interests and benefit consumers, and (3) Incorporating the factors into the traditional likelihood of confusion test is efficient and easily applicable.

Firstly, analyzing initial interest confusion within the factors test maintains the Lanham Act standard because the court will still engage in the likelihood of confusion analysis without the risk of using initial interest as a shortcut to find trademark infringement. Courts should still retain the power to decide whether or not some factors should be given more weight than others depending on the particular facts. Secondly, this approach will satisfy the trademark goals because it will keep the focus on consumer confusion instead of consumer diversion. Lastly, incorporating the factors is a timely solution for courts that are already familiar with their respective likelihood of confusion tests. This approach is not drastically different nor does it change the standard, so judges can easily transition into analyzing initial interest confusion within one of their pre-existing factors during the routine likelihood of confusion test.

IV. Conclusion

Post-Rescuecom recognition that use of another’s trademark to trigger keyword advertising is actionable trademark use will allow more Internet trademark infringement claims to pass summary judgment.[clviii] In response, courts need a streamlined test for how to apply initial interest confusion in the Internet. Among the confusing variations of the initial interest confusion doctrine, courts should incorporate the initial interest confusion analysis within the “evidence of actual confusion” factor or the “customer care” factor and continue to apply the traditional likelihood of confusion factors test. This formulation of the initial interest confusion doctrine will promote trademark law’s dual purpose of protecting trademark owners’ interest in the mark and protecting consumers.

[i][i]1.1 Overview of AdWords – AdWords Help,http://adwords.google.com/support/aw/bin/static.py?hl=en&guide=23611&pag…(last visited Oct. 3. 2010).

[ii]Id.

[iii]Id.

[iv][iv]See, e.g. Playboy Enters., Inc. v. Netscape Commc’ns Corp., 354 F.3d 1020, 1022-23 (9th Cir. 2004) (involving Netscape and Excite); Gov’t Employees Ins. Co. v. Google, Inc., 330 F.Supp.2d 700, 701-02 (E.D. Va. 2004) (involving Overture Services, Inc.).

[v]Search Ad Revenues Strong in Record-Breaking Half Year, IAB Reports #SEWatch, http://blog.searchenginewatch.com/101013-130544 (last visited Oct. 31, 2010).

[vi]How The World Spends Its Time Online – VisualEconomics.com,http://www.visualeconomics.com/how-the-world-spends-its-time-online_2010…(last visited Oct. 3, 2010).

[vii]See Brookfield Commc’ns, Inc. v. West Coast Entm’t Corp., 174 F.3d 1036 (9th Cir. 1999).

[viii]See, e.g., Rescuecom Corp. v. Google Inc., 562 F.3d 123, 127-31 (2d Cir. 2009) (involving keyword-based advertising); PACCAR Inc. v. TeleScan Techs., L.L.C., 319 F.3d 243, 247-48 (6th Cir. 2003) (involving both unlawful domain name and metatag use).

[ix]15 U.S.C. §§ 1051, 1051-1072, 1091-1096, 1111-1127 (2009).

[x]Id. at §1125.

[xi]See also Two Pesos, Inc. v. Taco Cabana, Inc., 505 U.S. 763, 782 at n.15 (Scalia, J., concurring) (quoting S. Rep. No. 1333, 79^th Cong., 2d Sess., 3, 4 (1946)); See Graeme B. Dinwoodie & Mark D. Janis, Trademarks and Unfair Competition: Law and Policy 15 (2d ed. 2007) (introducing the “two primary justifications … traditionally … offered in support of trademark protection”).

[xii]15 U.S.C. § 1125.

[xiii]15 U.S.C. § 1114(1).

[xiv]15 U.S.C. § 1125.

[xv]DeCosta v. Viacom Int’l, Inc., 981 F.2d 602, 605 (1st Cir. 1992); Checkpoint Sys., Inc. v. Check Point Software Tech., Inc., 269 F.3d 270, 279 (3d Cir. 2001).

[xvi]Id.

[xvii]Id.

[xviii]Id.

[xix]See Brookfield Commc’ns, Inc., 174 F.3d 1036 (using competitor’s mark as a metatag is actionable trademark use); Merck & Co., Inc. v. Mediplan Health Consulting, Inc., 425 F. Supp. 2d 402 (S.D.N.Y. 2006) (using plaintiff’s trademark for keyword advertising on Google’s AdWords is not actionable trademark use).

[xx]15 U.S.C. §1127.

[xxi]Mark Bartholomew, Article, Making a Mark in the Internet Economy: A Trademark Analysis of Search Engine Advertising, 58 Okla. L. Rev. 179, 187 (2005).

[xxii]PACCAR Inc. v. TeleScan Techs., L.L.C., 319 F.3d 243, 247-48 (6th Cir. 2003).

[xxiii]See supra note 5 (Search advertising is the largest form of online advertising, accounting for 47% of first-half spending at $5.7 billion in 2010, an increase of 11.6% compared to the first half of 2009 at$5.1 billion).

[xxiv]Rescuecom Corp. v. Google Inc., 562 F.3d 123, 129 (2d Cir. 2009).

[xxv] See, e.g., N. Am. Med. Corp. v. Axiom Worldwide, Inc.,522 F.3d 1211, 1220 (11th Cir. 2008) (“[A]xiom’s use of NAM’s trademarks as meta tags constitutes a ‘use in commerce…”); Google Inc. v. Am. Blind & Wallpaper, No. C 03-5340 JF (RS), 2007 WL 1159950, at *6 (N.D. Cal. Apr. 18, 2007) (“[T]he sale of trademarked terms in the AdWords program is a use in commerce for the purposes of the Lanham Act.”); Boston Duck Tours, LP v. Super Duck Tours, LLC, 527 F. Supp. 2d 205, 207 (D. Mass. 2007) (“Because sponsored linking necessarily entails the ‘use’ of the plaintiff’s mark as part of a mechanism of advertising, it is ‘use’ for Lanham Act purposes.”); Edina Realty Inc. v. TheMLSOnline.com, No. 04-4371JRTFLN, 2006 WL 737064, at *3 (D. Minn. Mar. 20, 2006) (“Based on the plain meaning of the Lanham Act, the purchase of search terms is a use in commerce.”); J.G. Wentworth, S.S.C. LP v. Settlement Funding LLC, No. 06-0597, 2007 WL 30115, at *6 (E.D. Pa. 2007); (“By establishing an opportunity to reach consumers via alleged purchase and/or use of a protected trademark, defendant has crossed the line from internal use to use in commerce under the Lanham Act.”).

[xxvi]See, e.g. Allard Enters. v. Advanced Programming Res., Inc., 146 F.3d 350, 355 (6th Cir. 1998) (internal quotations omitted) (describing the likelihood of confusion as the “touchstone of liability”); Thomas McCarthy, McCarthy on Trademarks and Unfair Competition § 23:1 (4^th ed. 2009) (noting that “the test of likelihood of confusion is the touchstone of trademark infringement”).

[xxvii]AMF Inc. v. Sleekcraft Boats, 599 F.2d 341, 346 (9th Cir. 1979).

[xxviii]Interpace Corp. v. Lapp, Inc., 721 F.2d 460, 463 (3d Cir. 1983) employing theLapp factors: (1) degree of similarity between owner’s mark and alleged infringing mark; (2) strength of owner’s mark; (3) price of goods and other factors indicative of the care and attention expected of consumers when making a purchase; (4) the length of time the defendant has used the mark without evidence of actual confusion; (5) the intent of the defendant in adopting the mark; (6) the evidence of actual confusion; (7) whether the goods are marketed through the same channels of trade and advertised through the same media; (8) the extent to which the targets of the parties’ sales efforts are the same; (9) the relationship of the goods in the minds of consumers because of the similarity of functions; and (10) other facts suggesting that the consuming public might expect the prior owner to manufacture a product in the defendant’s market or that he is likely to expand into that market.

[xxix]McCarthy, supra 26, at 23-29.

[xxx]See, e.g., Eli Lilly & Co. v. Natural Answers, Inc., 233 F.3d 456, 464 (7th Cir. 2000) (“Such confusion, which is actionable under the Lanham Act, occurs when a consumer is lured to a product by its similarity to a known mark, even though the consumer realizes the true identity and origin of the product before consummating a purchase.”); Playboy Enters., Inc. v. Netscape Commc’ns Corp., 354 F.3d 1020, 1025 (9th Cir. 2004) (“Initial interest confusion is customer confusion that creates initial interest in a competitor’s product. Although dispelled before an actual sale occurs, initial interest confusion impermissibly capitalizes on the goodwill associated with a mark and is therefore an actionable trademark infringement.”).

[xxxi]McCarthy, supra 26, at 23-28.

[xxxii]Dorr-Oliver, Inc. v. Fluid-Quip, Inc., 94 F.3d 376, 382 (7th Cir. 1996).

[xxxiii]Grotrian, Helfferich, Schulz, Th. Steinweg Nachf. v. Steinway & Sons (Grotrian II), 523 F.2d 1331, 1342 (2d Cir. 1975).

[xxxiv]Id. at 1333-34.

[xxxv]Id. at 716-17.

[xxxvi]Id. at 717.

[xxxvii]Id.

[xxxviii]Grotrian II, 523 F.2d 1331 at 1342.

[xxxix]Id.

[xl]Id.

[xli]Mobil Oil Corp. v. Pegasus Petroleum Corp., 818 F.2d 254 (2d Cir. 1987).

[xlii]Id. at 259.

[xliii]See Elvis Presley Enters, Inc. v. Capece, 141 F.3d 188, 203 (5thCir. 1998) (applying initial interest confusion to the name of a night club); Dorr-Oliver, Inc. v. Fluid-Quip, Inc., 94 F.3d 376, 382-83 (7th Cir. 1996) (applying initial interest confusion to trade dress infringement).

[xliv]See Promatek Indus., Ltd. v. Equitrac Corp., 300 F.3d 808, 812-13, (7th Cir. 2002) (applying initial interest confusion to metatags); Perfumebay.com Inc. v. eBay Inc., 506 F.3d 1165, 1176 (9th Cir. 2007) (applying initial interest confusion comparing two websites); PACCAR Inc., 319 F.3d at 253-54 (applying initial interest to domain name and meta tags); Gov’t Employees Ins. Co. v. Google, Inc., No. 1:04CV507, 2005 WL 1903128 at *4, (E.D. Va. Aug. 8, 2005). (recognizing initial interest confusion as a viable theory for keyed advertising).

[xlv]Brookfield Commc’ns, Inc. v. West Coast Entm’t Corp., 174 F.3d 1036 (9th Cir. 1999).

[xlvi]Id. at 1042.

[xlvii]Id. at 1041-43.

[xlviii]See Ira S. Nathenson, Note, Internet Infoglut and Invisible Ink: Spamdexing Search Engines with Metatags, 12 Harv. J. Law & Tech. 43, 62-63 (1998).

[xlix]Brookfield, 174 F.3d at 1062.

[l]Id.

[li]Id.

[lii]See J.G. Wentworth, S.S.C. LP v. Settlement Funding LLC, No. 06-0597, 2007 WL 30115 at *7 (E.D. Pa. 2007) (After discussing Brookfield, Judge J. O’Neill of the Eastern District of Pennsylvania states, “I respectfully disagree with the Ninth Circuit’s conclusion in Brookfield,” and refuses to apply initial interest confusion),and Bryce J. Maynard, Note, The Initial Interest Confusion Doctrine and Trademark Infringement on the Internet, 57 Wash. & Lee L. Rev. 1303, 1336-43 (2000) (Brookfield (1) does not protect consumer interests because Ninth Circuit failed to understand search engine mechanics and (2) does not protect trademark owners interests because initial interest confusion does not work when companies are not direct competitors).

[liii]Brookfield, 174 F.3d 1036 at 1062.

[liv]Id. at 1062 n. 24.

[lv]See Niki R. Woods, Note, Initial Interest Confusion in Metatag Cases: The Move from Confusion to Diversion, 22 Berkeley Tech. L.J. 393 (2007) (arguing against broad application of initial interest confusion in the Internet).

[lvi]Grotrian, Helfferich, Schulz, Th. Steinweg Nachf. v. Steinway & Sons (Grotrian II), 523 F.2d 1331, 1340 (2d Cir. 1975) and Mobil Oil Corp. v. Pegasus Petroleum Corp., 818 F.2d 254 at 259 (2d Cir. 1987).

[lvii]Brookfield, 174 F.3d at 1062.

[lviii]Zachary J. Zweihorn, Note, Searching for Confusion: The Initial Interest Confusion Doctrine and Its Misapplication to Search Engine Sponsored Links, 91 Cornell L. Rev. 1343, 1355-56 (2006) (“Because any time wasted would be de minimis, users interested in Brookfield’s product would be unlikely to feel that they had wasted so much time by clicking a link that seeking out the correct Web site would unacceptably raise their search costs.”).

[lix]See Note, Confusion in Cyberspace: Defending and Recalibrating the Initial Interest Confusion Doctrine, 117 Harv. L. Rev. 2387 (2004) (arguing that initial interest should apply in the Internet because under a cost-benefit analysis, the big cost of decrease in producers’ incentives to conduct business online and to provide consumers with high-quality online services does not outweigh the benefit to producers of cheap advertising from online trademark use).

[lx]Rachel R. Friedman, Note, No Confusion Here: Proposing a New Paradigm for the Litigation of Keyword Advertising Trademark Infringement Cases, 12 Vand. J. Ent. & Tech. L. 355, 379 (2010).

[lxi]PACCAR Inc. v. TeleScan Techs., L.L.C., 319 F.3d 243, 255-58 (6th Cir. 2003); Promatek Indus., Ltd. v. Equitrac Corp., 300 F.3d 808, 812-13, (7th Cir. 2002); Brookfield Commc’ns, Inc. v. West Coast Entm’t Corp., 174 F.3d 1036, 1062 (9th Cir. 1999); Australian Gold, Inc. v. Hatfield, 436 F.3d 1228, 1239-40 (10th Cir. 2006); Savin Corp. v. The Savin Group, 391 F.3d 439, 462 (2d Cir. 2004); 800-Jr Cigar, Inc. v. Goto.Com, Inc., 437 F.Supp.2d 273, 290 (D. New Jersey 2006).

[lxii]See supra note 28.

[lxiii]See discussion infra Parts II.B.1, II.B.2, II.B.3.

[lxiv]CompareHasbro, Inc. v. Clue Computing, Inc., 231 F.3d 1, 2 (1st Cir. 2000) (refusing to apply initial interest confusion) with Perfumebay.com Inc. v. eBay Inc., 506 F.3d 1165, 1176 (9th Cir. 2007) (applying initial interest confusion); CompareMorningware, Inc. v. Hearthware Home Products, Inc., 673 F.Supp.2d 630, 636-38 (N.D. Il. 2009) (no likelihood of confusion factor analysis) with Trans Union LLC v. Credit Research, Inc., 142 F.Supp.2d 1029, 1043-44 (N.D. Il. 2001) (analyzing initial interest confusion within “evidence of actual confusion” factor).

[lxv]Savin Corp. v. The Savin Group, 391 F.3d 439, 462 (2d Cir. 2004); Checkpoint Systems, Inc. v. Check Point Software Technologies, Inc., 269 F.3d 270, 297-98 (3d Cir. 2001); Interstellar Starship Servs., Ltd. v. Epix, Inc., 304 F.3d 936, 945 (9th Cir. 2002).

[lxvi]Savin Corp., 319 F.3d 439 at 446.

[lxvii]Id. at 456.

[lxviii]Savin Corp. v. The Savin Group, No. 02 Civ.9377 SAS, 2003 WL 22451731 at *12 (S.D.N.Y. Oct. 24, 2003).

[lxix]Id. at *12, *13.

[lxx]Savin Corp. v. The Savin Group, 391 F.3d 439, 462 (2d Cir. 2004).

[lxxi]Checkpoint Systems, Inc. v. Check Point Software Technologies, Inc., 269 F.3d 270, 297-98 (3d Cir. 2001).

[lxxii]Id. at 280.

[lxxiii]Id.at 297.

[lxxiv]800-Jr Cigar, Inc. v. Goto.com, Inc., 437 F.Supp.2d 273, 290 (D. N.J. 2006); JG Wentworth v. Settlement Funding LLC, No. 06-0597, 2007 WL 30115 at *7 (E.D. Pa. Jan. 4, 2007).

[lxxv]800-JR Cigar, Inc., 437 F.Supp.2d at 290.

[lxxvi]Id.

[lxxvii]Id. at 292.

[lxxviii]JG Wentworth, No. 06-0597, 2007 WL 30115, at *7.

[lxxix]Id. at *2.

[lxxx]Id. at *8.

[lxxxi]Perfumebay.com Inc. v. eBay Inc., 506 F.3d 1165, 1176 (9th Cir. 2007); Interstellar Starship Servs., Ltd. v. Epix, Inc., 304 F.3d 936, 942-46 (9th Cir. 2002); Storus Corp. v. Aroa Marketing, Inc., No. C-06-2454 MMC, 2008 WL 449835 at *4-5 (N.D. Cal. 2008); Google Inc. v. Am. Blind & Wallpaper, No. C 03-5340 JF (RS), 2007 WL 1159950 at *9-10 (N.D. Cal. 2007); Soilworks, LLC v. Midwest Industrial Supply, Inc., 575 F.Supp.2d 1118, 1130-33 (D. Ariz. 2008).

[lxxxii]Perfumebay.com Inc., 506 F.3d 1165 (9th Cir. 2007) (keyword advertising);Interstellar Starship Servs., Ltd., 304 F.3d 936 (9th Cir. 2002) (domain name);Storus Corp., No. C-06-2454 MMC, 2008 WL 449835 (N.D. Cal. 2008) (Google AdWords); Google Inc., No. C 03-5340 JF (RS), 2007 WL 1159950 (Google AdWords).

[lxxxiii]GoTo.com v. Walt Disney Co., 202 F.3d 1199, 1204 (9th Cir. 2000).

[lxxxiv]Id. at 1207.

[lxxxv]Brookfield Commc’ns, Inc. v. West Coast Entm’t Corp., 174 F.3d 1036, 1058 (9th Cir. 1999).

[lxxxvi]Interstellar Starship Servs., Ltd., 304 F.3d at 938.

[lxxxvii]Id. at 942-43.

[lxxxviii]Perfumebay.com Inc v. eBay Inc., 506 F.3d 1165, 1173-74 (9th Cir. 2007); Storus Corp. v. Aroa Marketing, Inc., No. C05-2454 MMC, 2008 WL 449835 at *5 (N.D. Cal. 2008).

[lxxxix]Perfumebay.com Inc., 506 F.3d at 1174-75.

[xc]Id. at 1168.

[xci]Id. at 1176.

[xcii]Id.

[xciii]Paccar Inc. v. TeleScan Technologies, L.L.C., 319 F.3d 243, 255-258 (6th Cir. 2003).

[xciv]Id. at 248-49.

[xcv]Id. at 248-49, 255, 258.

[xcvi]Id. at 255.

[xcvii]Australian Gold, Inc. v. Hatfield, 436 F.3d 1228, 1239-40 (10th Cir. 2006); Morningware, Inc.v. Hearthware Home Products, Inc., 673 F. Supp.2d 630, 636-38 (N.D. Ill. 2009); Gov’t Employees Ins. Co., No. 1:04CV507, 2005 WL 1903128 at *4 (E.D. Va. Aug. 8, 2005).

[xcviii]Morningware, 673 F.Supp.2d 630.

[xcix]Id. at 636-38.

[c]Id. at 633.

[ci]Id. at 636-7.

[cii]Promatek Industries, Ltd. v. Equitrac Corp., 300 F.3d 808, 812-13 (7th Cir. 2002).

[ciii]Id.

[civ]Id. at 813.

[cv]Morningware, Inc. v. Hearthware Home Products, Inc., 673 F.Supp.2d 630, 638 (N.D. Ill. 2009).

[cvi]Id.

[cvii]Id. at 636-38.

[cviii]Australian Gold, Inc. v. Hatfield, 436 F.3d 1228, 1239-40 (10th Cir. 2006) (Although the Tenth Circuit seems to base its decision on the fact that diversion is inherently damaging, it was also affirming the district court’s analysis under a six-prong factor test for likelihood of confusion, so it is not a complete departure from the likelihood of confusion test. In fact, the court briefly analyzed the factors and then discussed the inherently damaging effect of diversion after stating the plaintiffs did not offer any direct evidence of actual confusion. This suggests that the court did not even need initial interest confusion to find a likelihood of confusion and that stating diversion as inherently damaging was just a broad application of initial interest confusion.).

[cix]Id. at 1232.

[cx]Id. at 1233.

[cxi]Id.

[cxii]Id. at 1239-40.

[cxiii]Id. at 1239.

[cxiv]Id.

[cxv]Id. at 1240.

[cxvi]Id.

[cxvii]Woods, supra note 55, at 406-7.

[cxviii]15 U.S.C. § 1125.

[cxix]Woods, supra note 55, at 411-13 (arguing that courts are broadening the scope of initial interest by (1) giving goodwill too much importance in protecting trademarks’ goodwill rather than looking for confusion and (2) allowing misappropriation of goodwill to constitute use).

[cxx]Elvis Presley Enters., Inc. v. Capece, 141 F.3d 188, 203-4 (5th Cir. 1998).

[cxxi]Id. at 191, 193.

[cxxii]Id. at 204.

[cxxiii]Id.

[cxxiv]Id.

[cxxv]Id.

[cxxvi]Patrick Ryan Barry, Comment, The Lanham Act’s Applicability to the Internet and Keyword Advertising: Likelihood of Confusion v. Initial Interest Confusion, 47 Duq. L. Rev. 355, 366 (2009) (“If the court would find that a sponsored link advertisement lured an online customer into a website based on the use of a trademarked name, that court might be inclined to rule that there was initial interest confusion and trademark infringement even if the customer knew the true source of the website and its products before making a purchase.”).

[cxxvii]Elvis Presley Enters., Inc. v. Capece, 141 F.3d 188, 204 (5th Cir. 1998).

[cxxviii]Trans Union LLC v. Credit Research, Inc., 142 F. Supp.2d 1029, 1043-44 (N.D. Ill. 2001); Tdata Inc. v. Aircraft Technical Publishers, 411 F.Supp.2d 901, 908 (S.D. Oh. 2006).

[cxxix]Gibson Guitar Corp. v. Paul Reed Smith Guitars, LP, 423 F.3d 539, 550 (6th Cir. 2005).

[cxxx]Tdata Inc., 411 F.Supp.2d at 908 (“[T]he initial interest confusion doctrine is applicable as but one part of a relevant eight-factor inquiry.”).

[cxxxi]Id. at 904.

[cxxxii]Id. at 907.

[cxxxiii]Id. at 908-12.

[cxxxiv]Id. at 909.

[cxxxv]Id. at 908-12.

[cxxxvi]Promatek Indus., Ltd. v. Equitrac Corp., 300 F.3d 808, 812 (7th Cir. 2002); Mobil Oil Corp. v. Pegasus Petroleum Corp., 818 F.2d 254, 260 (2d Cir. 1987).

[cxxxvii]Mobil Oil Corp., 818 F.2d 254 at 260.

[cxxxviii]Id. at 812-14.

[cxxxix]BabyAge.com, Inc. v. Leachco, Inc., No. 3:08-cv-1600, 2009 WL 82552 at *8-12 (M.D. Pa. Jan. 12, 2009).

[cxl]Id.

[cxli]Id.

[cxlii]Id. at *6.

[cxliii]Id.

[cxliv]Id. at *10.

[cxlv]Id.

[cxlvi]Id.

[cxlvii]Id. at *12-13.

[cxlviii]Woods, supra note 55, at 405-6.

[cxlix]Id.

[cl]Australian Gold, Inc. v. Hatfield, 436 F.3d 1228, 1239 (10th Cir. 2006); Promatek Indus., Ltd. v. Equitrac Corp., 300 F.3d 808, 812-13 (7th Cir. 2002); See alsoWoods, supra note lxxiii at 411-12 (arguing against broadening initial interest confusion to protect trademarks’ goodwill rather than looking for confusion).

[cli]Woods, supra note 55, at 412.

[clii]Lamparello v. Falwell, 420 F.3d 309, 314 (4th Cir. 2005).

[cliii]15 U.S.C. § 1125.

[cliv]Barry, supra note 126, at 370.

[clv]Id.

[clvi]Id. at 371.

[clvii]See infra part II.B.3; see also Gregory R. Shoemaker, Comment, Don’t Blame Google: Allowing Trademark Infringement Actions Against Competitors Who Purchase Sponsored Links on Internet Search Engines Under the Initial Interest Confusion Doctrine, 58 Cath. U. L. Rev. 535, 564 (2009).

[clviii]See Note, supra note 59.

Feb. 25th Deadline Approaching for March Publication for the National Law Review Student Legal Writing Contest

Everybody’s talking about how abysmal the job market is for law students – why not build your resume while still in school? Young lawyers are under increasing pressure to start thinking about business development activities earlier than ever in their careers. One tried and true way of building one’s professional reputation is by publishing. One sure way to get noticed and to help others is to write in a style which is helpful and educational to prospective clients. The National Law Review is one of the nation’s premier resources for secondary legal analysis for businesses and in the Spring & Fall we offer students the opportunity to submit consumer-friendly articles for publication.

The winning articles will be published online starting March. The top article(s) chosen will be featured on the NLR home page and will remain in our searchable database for up to two years.

Please note that although students are encouraged to submit articles addressing Intellectual Property Law for the March publication, you may also submit entries covering current issues related to other areas of the law. Please spread the word !!! Thanks!

Should Jurors Use the Internet?

The National Law Review would like to congratulate Gareth Lacy of the University of Washington School of Law as one of our Fall 2010 Law Student Legal Writing Contest Winners!

During trials jurors are increasingly using cell phones and other devices capable of accessing the Internet. Courts are responding by amending court rules to explicitly ban these devices. This Article points out problems with these new court rules. This Article also reviews scientific literature on the effect of pre-trial publicity on jury decision-making to conclude some concerns about outside Internet research may be unwarranted. This Article exposes weaknesses in the arguments against allowing jurors to conduct outside Internet research.

Introduction

“Jurors are rarely brilliant and rarely stupid, but they are treated as both at once.” – Judge Warren K. Urbom[i]

“When lawyers speak about courtroom technology, they are typically debating the merits of making their presentations in Powerpoint.”[ii]

2010 is the year of mobile Internet. One quarter of all Americans get news via their cell phones.[iii] Amazon’s Kindle e-reader allows readers to carry thousands of novels and access the Internet with a single notepad-sized device. As jurors bring these devices into the courtroom, they are causing quite a commotion. Last year several courts ordered mistrials after discovering jurors had accessed Wikipedia or became Facebook friends with their fellow jurors during trial.[iv] Following a case in Florida that ended in mistrial, counsel told the New York Times that courts have been unprepared for this new technology in the courthouse: “It’s the first time modern technology struck us in that fashion, and it hit us right over the head.”[v]Now that 22 million U.S. cell phone users access the mobile Internet on a daily basis, courts must respond quickly and effect-tively.[vi]

This article will first explain why the recent response to increasing use of outside information—“just say no”—will be inadequate. Second, it will question the underlying assumption that access to outside information is always harmful. Third, it will argue that denying useful tools and information is unwise in the face of increasingly complex trials.

I. Judicial Response: “Just Say No”

Courts and commentators fear that access to the Internet could introduce bias into trial proceedings.[vii] The court rules and jury instructions are apparently designed to ensure jurors only consider evidence admitted at the appropriate time.[viii] But the underlying rationale for these rules is not made clear to jurors. Jurors are therefore likely to feel—rightly so—information is being hidden from them.

Courts have recently responded by drafting new jury instructions and admonitions. New York’s criminal jury instruction, for example, explains that basing opinions on news reports, rather than trial testimony, would be unfair to both parties:

Finally, our law requires that you not read or listen to any news accounts of the case, and that you not attempt to research any fact, issue, or law related to the case. Your decision must be based solely on the testimony and other evidence presented in this courtroom. It would not be fair to the parties for you to base your decision on some reporter’s view or opinion, or upon information you acquire outside the courtroom.[ix]

This is a slightly persuasive effort to explain the reasoning behind the court’s rule. An instruction in Oregon goes a bit further by explaining the rule in the context of everyday experience:

In our daily lives we may be used to looking for information on-line and to “Google” something as a matter of routine. Also, in a trial it can be very tempting for jurors to do their own research to make sure they are making the correct decision. You must resist that temptation for our system of justice to work as it should. I specifically instruct that you must decide the case only on the evidence received here in court.[x]

Again this instruction is better than nothing, but it still fails to explain why the “system of justice” requires restricting access to outside information. Any-thing short of transparent explanations will likely continue to feed jury—and public—mistrust for the legal system.

In February 2010, the U.S. Judicial Conference suggested jury instructions on the use of “electronic communication technologies.[xi] The instructions ban a laundry list of devices and resources—“blogs, websites such as Facebook, MySpace, LinkedIn, YouTube or Twitter, to communicate to anyone any information about this case or to conduct any research”—but fail to explain why jurors should not, for example, look up the definition of “lividity.”[xii] Again, if courts want to convince jurors not to “google” on their cell phones, they must give concrete explanations for the court rules.

Failure to explain the reason for a ban can create mistrust for the judicial system. A recent New York Times article on jurors’ use of the Internet gathered 300 comments in one hour,[xiii] some of which expressed belief in a “systemic effort to keep jurors from learning the truth . . . [in which] jurors, therefore, needed to dig deeper to uncover the truth.”[xiv] What can ease this mistrust? Clear and convincing explanations of judicial policies will help. Furthermore, giving jurors the tools and information in court that they need to make informed decisions in court will make them less likely to look out of court for answers.

II. Does Outside Research Really Bias Jurors?

After commentators raise concerns about jurors turning to extrinsic information, their most common recommendation is for courts to issue stronger admonitions to juries.[xv] Other suggestions include more vigorous voir dire or banning cell phones in the courthouse.[xvi] The problem with these recommen-dations is that courts are already doing most of these things. Juries are already told not to conduct outside research. Voir dire is about as vigorous as it can get.[xvii] Cell phone bans might help for one-day trials, but they will have no effect—and maybe even adverse effects—on multiday litigation. In short, commentators have offered few new suggestions for how to respond to juries using the Internet.

The reason these suggestions have been minimal is because they contain an underlying assumption that external information biases jurors. This assumption therefore restricts the judiciary’s options; if external information is always harmful, cell phone and Internet policies should not be liberalized. One California legislator who adopts this view introduced a bill imposing criminal penalties on jurors who access the Internet.[xviii] This assumption behind the restrictive policies—that external information is always harmful—should be questioned.

Courts and commentators have generally not given balanced appraisals of the scientific research on the effect of outside information on jury decision-making.[xix]For example, a recent article on jury Internet usage states confidently: “[j]urors may feel their searching is harmless and will not bias them, something that research has demonstrated is untrue.”[xx] But has scientific research really demonstrated outside research is always harmful? Indeed some research suggests jurors are influenced by pretrial publicity or negative information.[xxi] But the majority of these studies were laboratory simulations, not field studies of actual jury behavior.[xxii]Moreover, a close examination of the scientific evidence reveals more nuanced data than most courts and commentators have acknowledged.[xxiii]

Researchers have found, for example, that in federal criminal cases “it does not appear that highly publicized defendants are treated much differently in terms of ultimate conviction rates than defendants who receive no publicity at all.”[xxiv]Moreover, it was low levels of publicity that resulted in greater probability of conviction.[xxv] Other research found evidence that pretrial publicity did not influence trials outcomes.[xxvi] These results suggest that courts ought to focus on the content and quantity of the information jurors receive, rather than on outright bans.

Researchers have also found that when juries learn substantial and contrary information from evidence and judicial instructions during trial, they are capable of displacing information received before trial.[xxvii] In other words, prior beliefs are diluted by new, relevant information.[xxviii] When trial evidence is strong, this can reduce the effect of bias and external information: “the effect of irrelevant, inadmissible, or biasing information is reduced in its effect to the degree that relevant, probative evidence is available for the jurors’ considera-tion.”[xxix] Again, this suggests that courts should manage the flow of information rather than make unrealistic efforts to weed out all juror exposure to the Internet.

III. Giving The Internet A Second Chance

“A major question is whether the protective cocoon we want to preserve of the courtroom trial, where jurors calmly and dispassionately receive only relevant and reliable information based on evidentiary rules . . . can viably be maintained in the face of the informational tsunami pressing against it.”[xxx]

For decades, various groups of judges and scholars have called for better tools in the courtroom. They have argued for engaging jurors in the legal process by providing trial notebooks summarizing key information, allowing jurors to take notes, granting access to dictionaries, and allowing jurors to ask questions.[xxxi]These calls for juror engagement have met with vocal approval but have led to few concrete changes.[xxxii]

Jurors are not going to stop looking at outside information. The best way to keep jurors away from Wikipedia would be to sequester them. But sequestration is rarely practical on a large scale because it is prohibitively expensive and tends to promote mistrust for the jury system.[xxxiii] A more realistic response would be for attorneys and courts to conduct advance Internet research to identify what information about their case is available online, analyze that information, and then deal with it during trial. Another realistic response would be to give jurors the tools they need to make informed decisions in court so they do not need to conduct outside research.

Jurors want to know everything they can about a case so they can make informed decisions. But rather than promote the jury’s interest in Truth and Justice, courts tend to discourage curiosity and obscure information. For example, some courts still debate the “fairly recent innovation” of “allowing jurors to take notes during trial.”[xxxiv] Note-taking! And while some evidence shows judicial resistance to note-taking may be waning, individual judges still have the final say.

Juries were not always this sheltered. For four-hundred years after William the Conqueror’s reign, jurors were expected to investigate facts and “declare the truth” on the basis of personal knowledge.[xxxv] Even after sworn testimony became common in the sixteenth century, jurors were still permitted to ask questions. It was only when lawyers began to assert the function of law-making and law-finding that “[t]struggle for control over the jury came to a head.”[xxxvi] Rules of evidence then emerged to limit the information available to juries and to control how the information was received.[xxxvii] Jury power was ultimately curbed by strong demands from bankers, merchants, and industrialists for a more predictable—and sympathetic—legal system.[xxxviii] As for the prohibition against note-taking? That arose at a time when most jurors were illiterate.[xxxix]

Today the legal profession may be justified in exercising caution in some circumstances, but it is absurd to continue many of these traditional practices. Trials can involve hundreds of witnesses and thousands of exhibits. No juror can store all that information in his or her head. Even in shorter trials, jurors would be well-served by note-taking. Psychologists (and law students) have known for some time that the dual process of hearing and writing enhances retention.[xl] And lest there be any concern about the law: Trial judges are well within their authority to allow note-taking during trials.[xli]

In the early 1990s, one-hundred law professors, attorneys, judges, researchers, and representatives of business, insurance, and various interest groups met in North Carolina to consider the workings of the jury system and to recommend improvements. The participants did not agree about everything, but the overwhelming proportion strongly supported making jurors more active during trials:

Jurors need not and should not be merely passive listeners in trials, but instead should be given the tools to become more active participants in the search for just results. To that end, trial procedures and evidentiary rules should take greater advantage of modern methods of communication and recognize modern understanding of how people learn and make decisions.[xlii]

Jurors want answers to their questions. Some judges have begun to allow jurors to submit questions to the court and to allow attorneys to provide answers. This is a good start. But courts are competing with pocket-sized encyclopedias inside every cell phone, so they will need to explain to juries exactly why the court rules exist. And of course lawyers must be permitted to deliver useful information to reduce the desire to turn to outside sources.

Conclusion

“Once a new technology rolls over you, if you’re not a part of the steamroller, you’re part of the road.” – Stewart Brand

It is still quite fashionable to attack the jury system as moribund. Indeed jury participation is at an all-time low. Jurors report feeling unengaged. But it is not correct to blame the jury for the judicial system’s failures. Alexis de Tocqueville found a key purpose of the American jury was to be a “gratuitous public school” that empowers citizens with information about how to take charge of social affairs.[xliii] It is simply time to add some technology to this civics classroom. It is time to give jurors the tools they need to do their job.

[i]Warren K. Urbom, Toward Better Treatment of Jurors by Judges, 61 Neb. L. Rev. 409, 425 (1982).

[ii]Nancy S. Marder, Juries and Technology: Equipping Jurors for the Twenty-First Century, 66 Brook. L. Rev. 1257, 1273. (2001).

[iii] Kristen Purcell, et al., Understanding the Participatory News Consumer, Pew Research Center 5 (Mar. 1, 2010), available at http://www.pewinternet.org/~/media//Files/Reports/ 2010/PIP_Understanding_the_Participatory_News_Consumer.pdf.

[iv]John Schwartz, As Jurors Turn to Web, Mistrials Are Popping Up, N.Y. Times, Mar. 18, 2009, available at http://www.floridasupremecourt.org/decisions/probin/sc10-51_AppendixD.pdf.

[v] Id.

[vi]Enid Burns, Mobile Internet Usage Becomes the Norm for Many in U.S., Search Engine Watch, Mar 17, 2009, http://searchenginewatch.com/3633213.

[vii]Hillary Hylton, Tweeting in the Jury Box: A Danger to Fair Trials?, Time, Dec. 29, 2009, http://www.time.com/time/nation/article/0,8599,1948971,00.html.

[viii]Evan Brown, Some thoughts on jurors doing internet research – keep the process clamped down, Internet Cases, Jan. 2, 2010, http://blog.internetcases.com/2010/01/02/some-thoughts-on-jurors-doing-internet-research-keep-the-process-clamped-down/.

[ix] Jury Admonitions In Preliminary Instructions, May 5, 2009, www.nycourts.gov/cji/1-General/CJI2d.Jury_Admonitions.pdf.

[x]Gregory S. Hurley, Cell Phone Policies/Instructions for Jurors, Jur-E Bulletin, May 1, 2009, http://view.exacttarget.com/?j=fe4f1579726d04747313&m=ff3417737561&ls=fe03 13707667047d74147970&l=feee117976630d&s=fdf015757d6006757d127377&jb=ffcf14& ju=fe2116727c6d0778771377.

[xi]Proposed Model Jury Instructions The Use of Electronic Technology to Conduct Research on or Communicate about a Case (Jan. 28, 2010), http://www.wired.com/images_ blogs/threatlevel/2010/02/juryinstructions.pdf.

[xii]A Maryland appeals court threw out a first degree murder conviction after a juror, confused by the word “lividity” during a murder trial, looked up the term on Wikipedia. Del Quentin Wilber, Social networking among jurors is trying judges’ patience, Wash. Post, Jan. 9, 2010 at C01.

[xiii]John Schwartz, As Jurors Turn to Web, Mistrials Are Popping Up, N.Y. Times, Mar. 18, 2009, available at www.nytimes.com/2009/03/18/us/18juries.html.

[xiv]Douglas L. Keene & Rita R. Handrich, Online and Wired for Justice: Why Jurors Turn to the Internet, The Jury Expert 14 (Nov. 2009) http://www.astcweb.org/public/publication /article.cfm/1/21/6/Why-Jurors-Turn-to-the-Internet.

[xv]See,e.g., Ellen Brickman, et al., How Juror Internet Use Has Changed the American Jury Trial, 1 J. Ct. Innovation 297 (2008).

[xvi] See e.g., Anita Ramasastry, Why Courts Need to Ban Jurors’ Electronic Communications Devices, Findlaw, Aug. 11, 2009, http://writ.news.findlaw.com/ramasastry/20090811.html.

[xvii]Ironically some commentators have recommended doing background checks on jurors by using the very resources, for example Facebook, they seek to ban.

[xviii]Paul Elias, Courts finally catching up to texting jurors, Associated Press, Mar. 6, 2010, http://abcnews.go.com/US/wireStory?id=10028507.

[xix]Ellen Brickman, et al., How Juror Internet Use Has Changed the American Jury Trial, 1 J. Ct. Innovation 287 (2008).

[xx]Id. (emphasis added).

[xxi]See Brickman, et al., supra, note 19, at 290 nn. 2-8 (citing Amy L. Otto et al., The Biasing Impact of Pretrial Publicity on Juror Judgments, 18 Law & Hum. Behav. 453 (1994)); Christina A. Studebaker & Steven D. Penrod, Pretrial Publicity: The Media, the Law, and Common Sense,
3 Pscyhol. Pub. Pol’y & L. 428 (1997); Studebaker, et al., Assessing pretrial publicity effects: Integrating content analytic results, 24 Law & Hum. Behav. 317 (2000); Neil Vidmar, Case Studies of Pre- and Midtrial Prejudice in Criminal and Civil Litigation,26 Law & Hum. Behav. 73 (2002). None of these studies offer full support for Brickman et al.’s assertion that research on pretrial publicity is definitive. Otto et al., found negative information about a defendant’s character can influence initial judgments about the defendant’s guilt, but this bias is weakened by trial evidence. Otto et al., supra, at 453. Studebaker and Penrod assessed pretrial publicity effects reported in previous studies, but did not offer new evidence; they merely “propose[] a multimethod research approach by which meditational mechanisms can be assessed.” Studebaker & Penrod, supra, at 428. Studebaker et al., did not study juries per se, but instead conducted a content analysis of media coverage of the Oklahoma City bombing. Studebaker et al.,supra, at 317. Vidmar points out deficiencies in research on prejudicial publicity and explains how courts have rejected research based on laboratory simulations rather than actual case studies. Vidmar, supra, at 73.

[xxii]See Studebaker, et al., supra note 21, at 317.

[xxiii]SeeJon Bruschke & William E. Loges, Free Press vs. Fair Trials: Examining Publicity’s Roles in Trial Outcomes(2004).

[xxiv] Jon Bruschke & William E. Loges, Relationship Between Pretrial Publicity and Trial Outcomes, 49 J. of Comm. 104, 115 (1999).

[xxv]Id. at 114.

[xxvi]See e.g., J. L. Freedman & T. M. Burke, The Effect of Pretrial Publicity: The Bernardo Case, 38 Can. J. Criminology 253 (1996); John S. Carroll, et al., Free Press and Fair Trial: The Role of Behavioral Research, 10 Law & Hum. Behav. 187 (1986); D. R. Pember, Does Pretrial Publicity Really Hurt? 23(3) Colum. Journalism Rev. 16 (1984); H. E. Rollings & J. Blascovich, The Case of Patricia Hearst: Pretrial Publicity and Opinion, 27 J. of Comm. 58 (1977).

[xxvii]Rita J. Simon, Does the Court’s decision in Nebraska Press Association fit the research evidence on the impact on jurors of news coverage?, 29 Stan. L. Rev. 515 (1977); accord Martin F. Kaplan, Cognitive Processes in the Individual Juror, in The Psychology of the Courtroom 197 (1982); but see Geoffrey P. Kramer et al., Pretrial Publicity, Judicial Remedies, and Jury Bias, 14 Law & Hum. Behav. 409 (1990) (finding judicial admonition had no effect and deliberations exacerbated negative effects of factual or emotional information).

[xxviii]Martin F. Kaplan & Lynn E. Miller, Reducing the Effects of Juror Bias, 36 J. Personality & Soc. Pscyhol. 1443 (1978).

[xxix]Michael J. Saks, What Do Jury Experiments Tell Us About How Juries (Should) Make Decisions?, 6 S. Cal. Interdisc. L.J. 1, 28 (1997).

[xxx]Michael Hoenig, Juror misconduct on the Internet, N.Y. L.J., Oct. 8, 2009.

[xxxi]Interview by Donald C. Dilworth with Judge B. Michael Dann, Arizona Superior Court, Waking up Jurors, Shaking Up Courts, Trial, July 1, 1997, at 20, available athttp://www. thefreelibrary.com/_/print/PrintArticle.aspx?id=19634468; The Honorable B. Michael Dann, “Learning Lessons” and “Speaking Rights”: Creating Educated and Democratic Juries, 68 Ind. L.J. 1229, 1241 (1993); William W. Schwarzer, Reforming Jury Trials, 1990 U. Chi. Legal F. 199, 137 (1990); Warren K. Urbom, Toward Better Treatment of Jurors by Judges, 61 Neb. L. Rev. 409, 425 (1982).

[xxxii]ABA/Brookings Symposium, Charting a Future for the Civil Jury System 16 (1992).

[xxxiii]James P. Levine, The impact of sequestration on juries, 79 Judicature 266 (1995).

[xxxiv]Nancy S. Marder, Juries and Technology: Equipping Jurors for the Twenty-First Century, 66 Brook. L. Rev. 1257, 1276. (2001). Believe it or not, the merits of note-taking is still subject to some scholarly debate. See e.g., Victor E. Flango,Would Jurors Do a Better Job if They Could Take Notes?, 63 Judicature 436 (1979-1980); Steven D. Penrod & Larry Heuer, Tweaking Commonsense: Assessing Aids to Jury Decision Making, 3 Psychol., Pub. Pol’y & L. 259, 271 (1997); Irwin A. Horowitz & Lynee ForsterLee, The Effects of Note-Taking and Trial Transcript Access on Mock Jury Decisions in Complex Civil Trial, 25 Law & Hum. Behav. 373 (Aug. 2001).

[xxxv]Blackstone’s Commentaries on the Law 673-77 (Bernard C. Gavit ed., 1941).

[xxxvi]Morris S. Arnold, Law and Fact in the Medieval Jury Trial: Out of Sight, Out of Mind, 18 Am. J. Legal Hist. 267, 279 (1974).

[xxxvii]Lawrence M. Friedman, A History of American Law 101 (3rd ed. 2005).

[xxxviii]Morton J. Horwitz, The Transformation of American Law 1780-1860 140-41 (1977).

[xxxix]Nancy S. Marder, Juries and Technology: Equipping Jurors for the Twenty-First Century, 66 Brook. L. Rev. 1257 (2001).

[xl]Elizabeth F. Loftus, Memory 19-20 (1980).

[xli]See e.g., Johnson v. State 887 S.W. 2d 957 (Tex Crim. 1994); Sonja Larsen,Taking and use of trial notes by jury, 36 A.L.R. 5th 255 (1996).

[xlii]ABA/Brookings Symposium, supra note32, at16.

[xliii]Alexis De Tocqueville, 1 Democracy in America 266 (Henry Reeve trans., George Adlard 2d ed. 1838) (1830).

Time to Retire the ESOP from the 401k: Assessing the Liabilities of KSOP Structures in Light of ERISA Fiduciary Duties and Modern Alternatives

The National Law Review would like to congratulate Adam Dominic Kielich of Texas Wesleyan University School of Law as one of our 2010 Fall Student Legal Writing Contest Winners !!!

I. Introduction

401k plans represent the most common employer-sponsored retirement plans for employees of private employers. They have replaced defined benefit pension plans, as well as less flexible vehicles (such as ESOPs) as the primary retirement plan.¹ However; some of these plan models have continued their legacy through 401ks through structures that tie the two together or place one inside the other. A very common and notable example is the Employee Stock Ownership Plan (ESOP). ESOPs are frequently offered by companies as an investment vehicle within 401ks that allow participants to invest in the employer’s stock as an alternative to the standard fund offerings that are pooled investments (e.g. mutual funds or institutional funds). Participants may be unaware that the company stock option in their 401k is a plan within a plan. These combination plans are sometimes referred to as KSOPs.²

Although this investment vehicle seems innocuous, KSOPs generate considerable risk to both participants and sponsors that warrants serious consideration in favor of abandoning the ESOP option. Participants face additional exposure in their retirement savings when they invest in a single company, rather than diversified investment vehicles that spread risk across many underlying investments. They may lack the necessary resources to determine the quality of this investment and invest beyond an appropriate risk level. Moreover, sponsors face substantial financial (and legal) risk by converting their plan participants into stockholders within the strict protections of ERISA.³ The risk is magnified by participant litigation driven by the two market downturns of the last decade. Given the growing risk, sponsors may best find themselves avoiding the risks of KSOPs by adopting a brokerage window feature (sometimes labeled self-directed brokerage accounts) following the decision in Hecker.⁴

II. Overview and History of ESOPs

A. ESOP Overview

ESOPs are employer-sponsored retirement plans that allow the employee to invest in company stock, often unitized, on a tax-deferred basis. They are qualified defined contribution plans under ERISA. As a standalone plan, ESOPs take tax deferred payroll contributions from employees to purchase shares in the ESOP, which in turn owns shares of the employer’s stock. That indirect ownership through the ESOP coverts participants into shareholders, which gives them shareholder rights and creates liabilities to the participants both as shareholders and as participants in an ERISA-protected plan. They may receive dividends, may have the option to reinvest dividends into the plan, and may be able to receive distributions of vested assets in cash or in-kind, dependent upon plan rules.⁵

ESOPs offer employers financial benefits: they create a way to add to employee benefit packages in a manner that is tax-advantaged while providing a vehicle to keep company stock in friendly hands – employees – and away from the hands of parties that may seek to take over the company or influence it through voting. Additionally, ESOPs create a consistent flow of stock periodically drawn out of the market, reducing supply and cushioning prices. Moreover, with those shares in the hands of employees, who tend to support their employer, there are fewer shares likely to vote against the company’s decision-makers or engage in shareholder activism.⁶

B. Brief Relevant History of ESOPs

ESOPs are generally less flexible and less advantageous to employees than 401ks. ESOPs lack loan options, offer a single investment option, typically lack a hardship or in-service distribution scheme and most importantly, lack diversification opportunities. Individual plans may adopt more restrictive rules to maintain funds within the plan as long as possible, as long as it is ERISA-compliant. Perhaps the most important consequence of that lack of diversity is that it necessarily ties retirement savings to the value of the company. If the company becomes insolvent or the share price declines without recovery, employees lose their retirement savings in the plan, and likely at least some of the pension benefits funded by the employer. The uneven distribution of benefits to employees helped pave the way for ERISA in 1974.⁷

C. Current State of Law on ESOPs

1. ESOPs Within 401k Plans

After the ERISA regulatory regime paved the way for 401k plans, employers began folding their ESOPs and other company stock offerings into the 401ks. For decades employers could mandate at least some plan assets had to be held in company stock. When corporate scandals and the dot com bubble burst in 2001, it evaporated significant retirement savings of participants heavily invested in their employer’s stock, often without their choice. Congress responded by including in the Pension Protection Act of 2006 (PPA) by eliminating or severely restricting several permissible plan rules that require 401k assets in any company stock investment within 401k plans.⁸

2. ERISA Litigation of the 2000s

Participants who saw their 401k assets in company stock vehicles disappear with the stock price had difficulty recovering under ERISA until recent litigation changed how ERISA is construed for 401k plans. ERISA was largely written with defined benefit plans in mind. Defined benefit plans hold assets collectively in trust for the entire plan. Participants may have hypothetical individual accounts in some plan models, but they do not have actual individual accounts. ERISA required that suits brought by participants against the plan (or the sponsor, trust, or other agent of the plan) for negligence or malfeasance would represent claims for losses to the plan collectively for all participants, so any monetary damages would be awarded to the plan to benefit the participants collectively, similar to the shareholder derivative suit model. Damages were not paid to participants or used to increase the benefits payable under the plan.

Defined contribution plans with individual participant accounts, such as 401k plans and ESOPs, were grafted onto those rules. Therefore, any suit arising from an issue with the company stock in one of these plans meant participants could not be credited in their individual accounts relative to injuries sustained. It rendered participant suits meaningless in most cases because the likelihood of recovery was suspect at best.⁹

The Supreme Court affirmed this view in 1985 in Russell, and courts have consistently held that individual participants could not individually benefit from participant suits. Participants owning company stock through the plan could take part separately in suits as shareholders against the company, but these are distinguished from suits under ERISA. In 2008, the Supreme Court revisedRussell in LaRue and held that Russell only applied to defined benefit plans. Defined contribution plan participants could now bring claims individually or as a class and receive individual awards as participants. This shift represented new risks to sponsors that immediately arose with the market crash in 2007.¹⁰

III. Risks to Employees

The primary risk to employees is financial; a significant component of employee financial risk is the investment risk. 401k sponsors are required to select investments that are prudent for participant retirement accounts. This is why 401k plans typically include pooled investments; diversified investment options spread risk. ESOPs are accepted investments within 401k plans, although they are not diversified.¹¹ This increases the risk, and profit potential, participants can expose themselves to within their accounts. While added risk can be exponentially profitable to participants when the employer has rising stock prices or a bull market is present, the downside can also be significantly disastrous when the company fails to meet analyst expectations or the bears take over the markets.

Moreover, employees may be more inclined to invest in the employer’s stock than an independent investor would. Employees tend to be bullish about their employer for two reasons.¹² First, employees are inundated with positive comments from management while typically negative information is not disclosed or is given a positive spin. This commentary arises in an area not covered by ERISA, SEC, or FINRA regulations. This commentary is not treated as statements to shareholders; they arise strictly from the employment relationship. This removes much of the accountability and standards that otherwise are related to comments from the company to participants and shareholders. Management can, and should, seek to motivate its employees to perform as well as possible. While the merit of misleading employees about the quality of operations may be debatable, the ability to be positive to such an end is not.

Second, employees tend to believe in the quality of their employer, even if they espouse otherwise. They tend to believe the company is run by experienced professionals who are leading the company to long term success. Going to work each day, seeing the company operating and producing for its customers encourages belief that the company must be doing well. It can even develop into a belief that the employee has the inside edge on knowing how great the company is, although this belief is likely formed with little or no knowledge of the financial health of the company. The product of the internal and external pressures is a strong likelihood employees will invest in an ESOP over other investment options for ephemeral, rather than financial, reasons.¹³

Additionally, participants may have greater exposure to the volatility of company stock over other shareholders due to 401k plan restrictions. While some plans are liberally constructed to give participants more freedom and choice, some plans conversely allow participants few options. This is particularly relevant to the investment activity within participant accounts. Participants may be limited to a certain number of investment transfers per period (e.g. quarterly or annually), may be subject to excessive trade restrictions, or may even find themselves exposed to company stock through repayment of a loan that originated in whole or in part from assets in the ESOP. Additionally, the ESOP may have periodic windows that restrict when purchases or redemptions can occur. While a regular shareholder can trade in and out of a stock in seconds in an after-tax brokerage account, ESOP shareholders may find themselves hung out to dry by either the ESOP or 401k plan rules. These restrictions are not penal; they represent administrative decisions on behalf of the sponsor to avoid the added expense generally associated with more liberal rules.

Although employees take notable risk to their retirement savings portfolio by investing in ESOPs within their 401k plans, it can add up to a tremendous financial risk when viewed in the bigger picture of an employee’s overall financial picture. Employees absorb the biggest source of financial risk by nature of employment through the company because it is the major, if not sole, income stream during an employee’s working years. This risk increases if the employer is also the primary source of retirement assets or provides health insurance. The employee’s present and future financial well being is inherently tied directly to the employer’s financial well being. This risk is compounded if the employee also has stock grants, stock options, or other stock plans that keep assets solely tied to the value of the company stock. If the employee is fortunate enough to have a defined benefit plan (not withstanding PBGC coverage) or retirement health benefits through the company, then that will further tie the long term success of the company to the financial well being of the employee. Adding diversification in the retirement portfolio may be a worthwhile venture when those other factors are considered in a holistic fashion.

IV. Risks to the Sponsor

ERISA litigation is a serious risk and concern to sponsors. Although there is exposure in other areas related to participants as stockholders, ERISA establishes higher standards towards participants than companies otherwise have towards shareholders. Sponsors once were able to protect themselves under ERISA but since LaRue participants have an open door to reach the sponsor to recover losses related to the administration of the plan.¹⁴ ERISA requires sponsors to make available investment options that are prudent for 401k plans. The dormant side of that rule requires sponsors to remove investment options that have fallen below the prudent standard. Company stock is not excluded from this requirement.¹⁵

Any time the market value of the stock declines, the sponsor is at risk for participant losses for failure to remove the ESOP (or other company stock investment option) as an imprudent investment within the plan. Participants are enticed to indemnify losses through the sponsor. Such a suit is unlikely to succeed when the loss is short term and negligible, or the value declined in a market-wide downturn. However, as prior market downturns indicate, investors look to all possible avenues to indemnify their losses by bringing suits against brokers, advisors, fund companies, and issuers of their devalued assets. There is no reason to believe that participants would not be enticed to try this route; LaRuewas born out of the downturn in the early 2000s.¹⁶

The exposure for sponsors runs from additional costs to mount a defense to massive monetary awards to indemnify participants for losses. In cases where participants are unlikely to recover, sponsors still must finance the defense against what often turns into expensive, class action litigation or a long serious of suits. However, there is a serious risk of sponsors having to pay damages, or settle, cases where events have led to a unique loss in share value. Participants have filed suit under the theory that the sponsor failed to remove imprudent investment options in a timely fashion. BP 401k participants filed suit following the gulf oil leak under a similar theory that the sponsor failed to remove the company stock investment option from the plan, knowing that it would have to pay clean up costs and settlements. While it remains to be seen if these participants will be successful, they surely will not the last to try.¹⁷

Sponsors should take a good, long look at the ESOP to determine whether the sponsor receives more reward than risk – particularly future risk – from its inclusion. The risk to a company does not have as severe as the situation BP faced this year. Even bankruptcy or mismanagement that results in serious stock decline can merit suit when the sponsor fails to immediately withdraw the ESOP, since it has prior knowledge of the bankruptcy or mismanagement prior to any public release.

To hedge these risks, sponsors can adopt several options. First, sponsors may limit the percentage of any account that may be held in company stock. This is easily justified as the sponsor taking a position in favor of diversification and responsible execution of fiduciary duties. While this may not completely absolve the sponsor of the duty to remove imprudent investment options, it does act as a limit on liability. Although it does provide some protection against risk, it is an imperfect solution.

Second, ESOP plans can adopt pricing structures to discourage holding large positions of company stock for the purpose of day trading. Some 401k plans allow participants to trade between company stock and cash equivalents without restraint. When the ESOP determines share pricing based on the closing price of the underlying stock, it creates a window where participants can play the company stock very differently than the constraints of most 401k investment options.

It is a very alluring reason to take advantage of the plan structure by taking an oversized position in company stock. Add the possibility to indemnify losses in court and it becomes even more desirable. The process is simple: participants can check the trading price minutes before the market closes. If the stock price is higher than the basis, they sell and net profit. If it is below, they hold the stock and try against each day until the sale is profitable. They will then buy back into the ESOP on a dip and repeat the process. This is distinguishable from the standard diversified fund options in 401k plans, where ignorance of the underlying investments preempts the ability to game closing prices. Funds generally discourage day trading – and may even carry redemption fees to penalize it – and encourage long term investing strategies more consistent with the objective of retirement accounts.

Available solutions are directly tied to the cause of the problem; changing the ESOP pricing scheme can eliminate gaming closing prices. ESOPs can adopt other pricing schemes such as average weighted pricing and next day order fulfillment. Average weighted pricing gives participants the average weighted prices of all transactions in the stock, executed that day, by a given entity. For example, if the ESOP is held with Broker X as the trustee, it may rely upon Broker X to provide the prices and volumes of all of its executed orders that day in the stock, which is used to determine the average weighted price participants will receive that day. Alternately, participants could be required to place orders on one day and have the order fulfilled on the following day’s closing with that day’s closing price. Both of these pricing schemes introduce some mystery into the price that diminishes gaming the closing price. This is also an imperfect solution, even if combined with the first option, because it maintains the risks of the ESOP.

Sponsors may also take advantage of brokerage windows to expand employee investment options, including company stock, without the risks afforded to ESOPs. Brokerage windows create brokerage accounts within 401k plans. The brokerage window is not an investment in itself; it is a shell that allows employees to reach through the window to access other investments. Sponsors found good reason to be suspicious of brokerage windows, seeing it as liability for all the available investments that could be deemed imprudent for retirement accounts. A minute minority of participants saw it as a way to have their cake and eat it too during the last rise and fall of the markets; they could invest more aggressively within their 401ks and then demand sponsors indemnify their losses when the markets gave up years of gains on the basis of sponsor failure to review the available contents of the window under the prudence standard.

However, in Deere the court handed down a critcal decision: sponsors could not be responsible for the choices made by participants within brokerage windows. InDeere, several Deere & Co. (John Deere) employees sued the company for making available investments that were imprudent for 401k accounts that caused substantial losses in the 2007 market downturn. John Deere had not reviewed the thousands of available options under the ERISA prudence standard. Although the plaintiffs’ theory was a compelling interpretation of ERISA duties, the court rejected the theory on two grounds. First, it would be impossible for any sponsor to review every investment available through the window. Second, participants had taken ownership of the responsibility to review their investment decisions by choosing to invest through the window.¹⁸

Following the court’s decision in Deere, brokerage windows gained new life as a means for sponsors to expand investment availability at less risk. Rather than having to review a menu of funds and company stock for prudence under ERISA, sponsors can justifiably limit the fund selection directly offered through the plan and leave the rest of the options to the brokerage window. Importantly, this includes offering company stock in the window. By utilizing the brokerage window, sponsors allow access to the company stock without the liabilities of offering an ESOP through the plan. The sponsor will likely lose out on any benefits received from the ESOP, although for most established employers ESOPs are likely more of a convenience factor and a legacy offering rooted in the history of employer-sponsored plans.

Although Deere foreclosed participant abuse of brokerage windows, this option is not without its own negative aspects. Future litigation may reestablish some liability upon the sponsor for the brokerage link. Sponsors may face alternate liability under ERISA for selecting a brokerage window with excessive commissions or fees, similar to requirements for funds under ERISA.¹⁹ Given the flurry of awareness brought to 401k management fees and revenue sharing agreements between sponsors and fund providers following the market crash in 2007, it is likely that brokerage windows will be the hot ticket for participants in the next market crash. Therefore, sponsors should preemptively guard against future litigation by reviewing available brokerage window options to make sure any fees or commissions are reasonable and the categories of investment options are reasonable (even if specific investments in those categories are not).

Perhaps a lesser concern, sponsors need to consider overall plan operation and any negative impacts that may arise from shifting to a brokerage window-based investment offering. These concerns may be less of a legal risk issue than a risk of participant discontent and dealing with those effects. There are primarily two areas that brokerage windows can create discontent. First, when participants want to move from a fund to the brokerage window, they must wait for the sale to settle from the fund and transfer to the window, which generally makes the money available in the window the day after the fund processes the order. Conversely, selling investments in the window may delay transferring money into plan funds because of settlement periods and the added delay of settlement with the fund once the funds are available to move out of the window. Additionally, the settlement periods within the window may frustrate participants, although the plan has no control over those timeframes. Those natural delays in processing the movement of money may create discontent, especially for those participants trying to invest based upon short term market conditions.

Second, those same processes and delays can negatively affect plan distributions. Many plans offer loans and withdrawal schemes, and while sponsors may have their own reasons for making those options available, participants often use those offerings to finance emergency financial needs. Brokerage windows can complicate and delay releasing money to participants. Settlement periods will create delays; if money has to be transferred out of the window to another investment to make those funds available for a distribution that will add at least one more day before money can be released. If participants find themselves in illiquid investments, the money may not be able to move for a distribution at all. Although these issues may not be of legal significance but they will be significant to the people responsible for absorbing participant complaints and there may be additional expenses created in handling those issues.

An additional concern is that the Department of Labor (DOL) is still fleshing out several requirements surrounding brokerage windows and how they relate to ERISA requirements. For example, the DOL October 2010 modification of 401k disclosure rules affects plans as a whole, but it leaves open several areas of ambiguity around the specific effects on brokerage windows. Sponsors may face continuing financial costs complying and determining how to comply with DOL requirements. Future changes in the regulations may negatively affect plans that rely heavily on brokerage windows to provide access to a greater range of investment options.²⁰

These considerations are not exhaustive to the benefits or risks of either ESOPs or brokerage windows, they merely highlight some of the more salient points as they relate generally to the legal and significant financial benefits and risks to sponsors. There may be additional concerns equally salient to sponsors given their particular situation, such as participant suspicion of the removal of the ESOP or unwillingness at the executive level to retire the ESOP.

V. Conclusion

Although brokerage windows may open the door to some new liabilities, it closes the door to the risks of ESOPs, for both participants and sponsors. Sponsor diligence in administering retirement plans will always be the most successful method of checking liability; however, as discussed ESOPs risk putting sponsors in an unwinnable position. Removing the company stock option may not be the most beneficial option in all cases but it may be time for sponsors to consider retiring the ESOP from the 401k in light of the current regulatory regime. A brokerage window option is well suited to take advantage of participant ownership of the employer’s stock, as well as other investment opportunities, while limiting the risk that normally accompanies that ownership. Ultimately, sponsors must consider what is best for the plan and its participants over both the short term and the long term.

Endnotes.

1. Chris Farrell, The 401(k) Turns Thirty Years Old, Bloomberg Businessweek Special Report, Mar. 15, 2010,http://www.businessweek.com/investor/content/mar2010/pi20100312_874138.htm.

2. National Center for Employee Ownership401(k) Plans as Employee Ownership Vehicles, Alone and in Combination with ESOPs, (no date provided),http://www.nceo.org/main/article.php/id/15/.

3. Id.; 29 U.S.C. § 1104 (2010); the term “sponsor” can be used interchangeably with “employer” for purposes of this discussion, however there are some situations where the employer is not the sponsor, such as union plans, or the employer is not the sole sponsor in the case of multi-employer plans. This discussion relates to KSOPs where the sponsor is the employer. Different rules and different liability may apply to other plan structures.

4. Hecker v. Deere & Co., 556 F.3d 575, 590 (7^th Cir. 2009), cert. denied, 130 S. Ct. 1141 (2010).

5. Todd S. Snyder, Employee Stock Ownership Plans (ESOPs): Legislative History, Congressional Research Service, May 20, 2003.

6. William N. Pugh et al. The Effect of ESOP Adoptions on Corporate Performance: Are There Really Performance Changes?, 21Managerial & Decision Econ., 167, 167-180 (2000).

7. Supra note 5.

8. Pension Protection Act of 2006 § 901, 29 U.S.C. 401 (2010).

9. LaRue v. DeWitt, Boberg & Assocs., Inc., 552 U.S. 248, 254-55 (2008).

10. Id. at 255-56.

11. Shlomo Benartzi et al., The Law and Economic of Company Stock in 401(k) Plans, 50 J.L. & Econ. 45, 45-79 (2007).

12. Id.

13. Id.

14. LaRue, 552 U.S. at 254-55.

15. § 1104.

16. LaRue, 552 U.S. at 250-51.

17. E.g., In Re: BP P.L.C. Securities Litigation, MDL No. 2185, 2010 WL 3238321 (J.P.M.L. Aug. 10, 2010).

18. Hecker, 556 F.3dat 590.

19. §1104.

20. 29 C.F.R. § 2550 (2010).

Alternatives to International Criminal Justice – Restorative Justice and Peace Through Peaceful Means

The National Law Review would like to congratulate Heejung Park of Washington University in St. Louis as one of our Fall 2010 Law Student Legal Writing Contest Winners!

“Out of timber so crooked as that from which man is made nothing entirely straight can be carved.” -Immanuel Kant-

Individuals live their own lives, and have their own goals. An entity may be an individual, a group, or a nation. The purposes of two parties may be in harmony with each other and without conflict, or may not. Such purposes may be good, or evil. Essentially, problems occur when the purposes of two or more parties do not coincide. The basic position of the traditional criminal justice system is to address problems simply by punishing the perpetrators. However, over the last several decades, there have been new studies in the area of peace and human rights, and in this environment, new institutions may be welcome. This is inspiring changes from the perspective of human integrity and the right to peace, which pursues harmonious coexistence.

If the criminal justice system, which aims to punish perpetrators, takes an interest in the perpetrators as well as the victims by enabling the perpetrators to truly repent for their offenses and voluntarily make restitution to their victims, while allowing the victims to accept the restitution based on a principle of forgiveness and tolerance, a foundation for peace and respect of others in the community will be formed. As such, it is very significant to prepare for a system wherein the pepetrator and the victim can remediatetheir hurt,and recover. If we are working from a principle that values life above all, and values human rights to the extent that they carry more weight than the earth itself, such an approach must be inspiring. It is not that easy to buildasociety that is better and more peaceful, in which everyone can live together harmoniously. When criminals are punished, this does not mean that everything has been resolved. Often,the root causesof a crime can be foundin the community, or even in the victim himself or herself. On this basis, victims and communities also have a responsibility to take an interest in the perpetrators of crimes. The intent must be to identify the fundamental causes of crimes, and by addressing these causes, to create a better society and a better country, byseeking an alternative to the international criminal justice system based on peaceful means.

To achieve this, one or more of the following three approaches may be effective. The first is to constitute a truth commission to pursue truth and reconciliation. This approach has been successful in South Africa, as well as in some Latin American and Asian countries. Truth will be identified, and reconciliation will be made based on investigations into violations of human rights and provisions concerning ethical and legal responsibilities and duties. The Report of the Truth and Reconciliation Commission that was prepared by the government of South Africa in 2003 also addressed this issue. Through the Truth and Reconciliation Commission, violations of human rights relating to apartheid have been addressed.[i] The second is to hold public inquiries. This is closely related to post-conflict management. “Bloody Sunday[ii]” in the UK is a representative sample. In this event, 13 people were shot to death and several were injured on January 30, 1972, a Sunday. A high-profile public inquiry, it was led by English Supreme Court Justice Mark Saville together with a judge from New Zealand and a judge from Canada, and was established on April 3, 1998. The last is “Community-based Restorative Justice”, which is the most important and is addressed intensively herein. This is a mechanism that focuses on the post-conflict environment, and is deeply related to the peaceful coexistence of a community. In this area, new justice systems have emerged, called “gacaca” and restorative justice.[iii] Gacaca is a new court system that was launched by the Rwandese government on June 18, 2002. This new court system follows the customary system for community hearings, which have been used whenever a conflict occurs in the community. Begun at a Canadian church in the 1970s, restorative justice is a crime-fighting approach for victim-sensitive victim-offender mediation.

Criminal prosecution is not always the right solution. It is a good method only when it can benefit society and nation. If we acknowledge that unexpected pitfalls exist for everyone, then people should be given one more chance, even if they have committed a crime. The proposition of the “restoration of offenders” is not suitable for all conflicts. Nonetheless, it is a new approach to consensus, and aims at facilitating mutual understanding. The Bible features an approach similar to this restorative justice.[iv] It also refers to accountability for healing that goes through discipline to move toward a peaceful environment, which is different from the existing criminal justice system.[v] The Bible considers every individual a sinner. It says that an individual can receive forgiveness when he/she sincerely repents, surrenders to God, and produces the fruit of repentance.[vi] It further says that reconciliation will take place when one makes restitution and reparation for the harm, and this action bears fruit.[vii] When this is done, the offender is able to commit himself/herself to the community and the nation by producing the fruit of the Spirit[viii], through his/her indebtedness and freedom from being forgiven. Curing offenders, allowing them to repent for their wrongdoings and to voluntarily make restitution and reparation, a win-win situation for perpetrator and victim, is possible in the love of God through the remediation of hurt, restoration, forgiveness, and tolerance. Through this, the community can seek peace through social justice and tolerance. Both perpetrators and victims have fundamental rights as human beings. In this area, the roles of national reconciliation/mediation agencies, protection agencies, and NGOs are important.

These approaches may equally be applied to international criminal justice. As demonstrated above, post-conflict management should be approached peacefully. Disputes occur when the purposes of parties do not coincide with each other. This discord emerges in the form of conflict. A conflict is a polarization of opinions or powers. Ultimately, such polarization may reach the level of violence, which leaves residual trauma. This process repeats itself, continuously. The ring of this vicious circle should be peacefully severed. Such an approach to peaceful means advocates solving problems through mediation (this is directed toward the future, and it is better than “victory”) at the stage of conflict; through the positive involvement of peace-building at the stage of polarization; and through nonviolence rather than violence, and reconciliation and conciliation (which is against the past, and requires healing) instead of trauma.

[i]Mark Freeman, Truth Commissions and Procedural Fairness, Part 1:‘Introduction’ 3 (Cambridge University Press, 2007).

[ii]Angela Hegarty, “Truth, Law and Official Denial: The Case of Bloody Sunday”15Criminal Law Forum 199 (2004).

[iii]Phil Clark, “Hybridity, Holism and ‘Traditional’ Justice: The Case of the Gacaca Community Courts in Post- Genocide Rwanda”, 39 Geroge Washinton International Law Review 4 20 (2007).

[iv]Tony F. Marshall, Restorative Justice An Overview 6 (Research Development and Statistics, 1998).

[v]Edward Bouverie Pusey, The Confessions Of Saint Augustine 5-6 (Kessinger Publishing, 2004).

[vi]Matthew, New International Version Bible,The New Testament: Matthew 2 (Word Of Life Press, 2009).

[vii]Jeremiah, New International Version Bible, The Old Testament: Jeremiah 706 (Word Of Life Press, 2009).

[viii]Paul, New International Version Bible, The New Testament: Galatians 185 (Word Of Life Press, 2009).

I. Introduction

II. Background

A. The Mechanics of Internet Sales Taxation

B. National Bellas Hess, Inc. v. Department of Revenue of Illinois

C. Quill Corp. v. North Dakota

D. Streamlined Sales and Use Tax Agreement

A. Congressional Efforts to Regulate Internet Sales Taxes

B. Recent State Efforts to Bypass Quill’s Substantial Nexus Requirement

a. Borders Online v. State Board of Equalization

b. Amazon.com, LLC v. New York State Department of Taxation and Finance

c. The Bordersand AmazonFallout

d. The Case for a Federal Solution

III. Main Street Fairness Act

A. Enforce Current Laws

B. Level the Playing Field

C. Bridge the Budget Gap

IV, Conclusion

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1. Introduction

2. The In Pari Delicto Doctrine

a) Background

b) The Second Circuit’s Approach

c) Approaches of Other Circuits

3. Standing Issues The Trustees Face

a) Background

b) The Shifting Focus of the Second Circuit

c) Approaches of Other Circuits

4. Conclusion

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II. § 506(a) BACKGROUND AND WILLFULNESS STANDARD

III. FAIR USE

IV. POLICY CONSIDERATIONS

V. CONCLUSION

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I. HISTORY: THE GUIDEPOSTS: 1972-2008

II. CREATION OF THE ABSTRACT TEST: IN RE BILSKI & BILSKI V. KAPPOS

III. THE CURRENT FUTURE OF THE BUSINESS METHOD

IV. DISAGGREGATION: A SOLUTION

A. FINANCIAL ABSTRACT TEST

B. SOFTWARE ABSTRACT TEST

CONCLUSION

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Introduction

A. The Development of the TRIPS Agreement

B. Access to Medicine Consequences

C. A Call for the Doha Declaration on the TRIPS Agreement and Public Health

Parallel Imports

Compulsory Licensing

II. Circumventing the Doha Declaration Through TRIPS-Plus Agendas

A. TRIPS-Plus Obligations in Free Trade Agreements

Special 301 Watch List

B. TRIPS-Plus Obligations in Regional Agreements: The Case of EU Council Regulation 1383/2003

III. The Anti-Counterfeiting Trade Agreement

A. Access to Medicine Threats Posed by ACTA

B. New IP Law-Making in the Process?

IV. ACTA’s Unofficial Drafting History: Establishing An Intent to Promote Access to Medicine

V. CONCLUSION

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I. Background Information

A. Use in Commerce

B. Likelihood of Confusion

II. Initial Interest Confusion

A. Introduction to Initial Interest Confusion

B. Criticism and Proposal for Courts Applying Initial Interest Confusion

1. Courts analyzing initial interest confusion separately before or after the traditional likelihood of confusion test

2. Courts analyzing only initial interest confusion or giving undue weight to diversion

3. Courts analyzing initial interest confusion within the “evidence of confusion” or “customer care” factor of the traditional likelihood of confusion test

III. Criticism of Tests 1 and 2 and Proposal for Courts to Adopt Test 3

A. Criticism of Tests 1 and 2

B. Proposal for Test 3

IV. Conclusion

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**2. The In Pari Delicto Doctrine**