Recently China IP was one of the first IP journals to cover a new IP trend in U.S. law. An article The New Unfair Competition Act of the State of Washington and Its Effects on the Manufacturing Industry of China by Zhang Guangliang, reported that Washington State (not Washington DC) amended its consumer protection law to permit the State Attorney General’s Office (AG) or a private party to block the sale of goods violating the state’s “stolen or misappropriated information technology” law. The definition includes traditional IP topics, such as pirated software and counterfeit goods. The law could also covers developing IP issues. The recent verdict in favor of Apple over Samsung included IP violations that mimicked functionality. This month China IP is focusing on whether similarities in a graphic user interfaces (GUI) could violate IP law. Though there have been many articles outlining the law, it is hard to predict where the law will be applied. If, for example, one state states that a GUI is too similar to an existing GUI, would another state have to recognize it. If many states pass similar laws could plaintiffs “forum shop” and bring actions in states where they are most likely to win or where there is case law that favors their position.

This article will expand on the analysis of the Washington State law. First this article will note that there is a movement in the U.S. towards a greater use of state laws to fix problems citizens feel the federal government has failed to address. It will then summarize what constitutes a violation of the Washington State law, potential plaintiffs and defendants and provide advice on how to avoid violating the law. It also attempts to provide a checklist to help readers determine whether their businesses fall within the provisions of the law and what affirmative defenses and proactive measures a manufacturer can take to improve IP security in their contracts, communications and other agreements.

This article relies on a variety of sources. As a result there are inconsistent terms. Different sources do not use the same terms to refer to the same thing. There are two places where this might cause confusion to readers. The first is “IP” and “IT.” Readers should assume these two terms mean the same thing. Both of these terms refer to our common understanding of intellectual property. The second is “Product Seller” and “defendant.” Readers should assume these two terms mean the same thing. Both refer to the party accused of violating the law.

On November 4th, 2011, 36 states made what might historically be remembered as a new “Declaration of Independence” in the battle between state and federal rights in IP enforcement. The debate during state hearings provide a stunning example of how states feel and what they plan to do. During the public testimony stage, supporters for the law stated, “International law has failed us and we have a duty to protect the information technology of American companies.” Though the state interest goal of protecting state citizens hasn’t changed, the reach of justification used by state legislators has changed immensely. Since the NAAG letter was the first salvo sent out by the states to the FTC, it is critical to review that letter in its entirety to grasp the new range of justifications being used by the states. The letter states:

“As Attorneys General, we represent 36 states and 3 U.S. territories that are home to 186.2 million consumers and 184,131 manufacturing businesses with 6,720,200 employees. Our states and territories receive $801.3 billion annually in manufacturing imports from around the world. Over the past decade, our states have been hard hit by the decline in domestic manufacturing. Indeed, from 2001 to 2008 alone, some 2.04 million jobs across the U.S. have been replaced by manufacturing in China, India, Mexico and Russia. While we recognize that our manufacturers must compete in the global economy, our companies should not be forced to compete on an unfair playing field. That is why each of us is seeking ways to use the traditional power of our offices to address the unfair advantage that results when foreign and other manufacturers use stolen information technology, including pirated software, to illegally slash their costs. Such unfair competition hurts law-abiding businesses in our states, costing jobs and slowing economic recovery.

 

Competition is the bedrock of free enterprise. Healthy, fair competition, whether between U.S. companies or between U.S. and foreign producers, creates opportunities for innovation and growth that provide consumers with greater choices, better products and lower costs. It also offers producers access to new markets, customers, innovation, revenue growth and the ability to create new jobs in our states. Open markets in the U.S. are based on these principles. Competition is unfairly distorted, however, when a manufacturer gains a cost advantage by using stolen information technology, whether in its business operations or manufacturing processes. It offends our sense of fairness when such wrongdoers reap a commercial advantage from their illegal acts.

Theft of intellectual property is endemic in countries to which our manufacturing jobs have been transferred. Indeed, the piracy rates for software in some of our largest trading partners are above 80% and in some cases, above 90%. The theft of our intellectual property represents economic losses not only to U.S. information technology companies, but also real losses to law-abiding manufacturers doing business in our states that pay the costs of legally acquiring information technology. In the course of researching this issue, we have encountered compelling examples:

l  A California-based apparel manufacturer must compete with an Indian manufacturer that steals over $14 million in software;

l  A Washington-based paper mill must compete with a Mexican paper manufacturer that uses over $10 million in stolen software;

l  An Indiana-based parts manufacturer must face a Chinese competitor that steals over $5.2 million in software.

The importance of the manufacturing sector to the U.S. economy cannot be overstated. One in six private sector jobs depends on the U.S. manufacturing base. Every $1 in sales of products manufactured in the U.S. contributes $1.40 in output from other sectors, the largest multiplier among all sectors of our economy.

Many of our states have laws that can be used to address this harm, including statutes patterned after the Federal Trade Commission Act, other consumer protection laws and, in the case of Washington and Louisiana, statutes specifically designed to address this problem. We believe that the use of stolen information technology causes precisely the type of anti-competitive harm that these statutes are intended to remedy. In fact, the original focus of the Federal Trade Commission Act (on which the state versions of the Act are based) was on unfair methods of competition that impacted competitors, not consumers. Theft of information technology is the type of competitive wrong that falls easily within the traditionally broad definition of unfair methods of competition.

We are committed to exploring the enforcement of these and other state statutes to attack this problem and to ensure a level playing field for manufacturers selling their goods in our states. We urge you to consider how the unfair method of competition prohibition in Section 5 of the Federal Trade Commission Act itself can be brought to bear on this problem at the federal level. Your leadership in this effort is particularly important given the fact that not all states have enacted versions of the Federal Trade Commission Act or other laws that could be used to address these serious competitive problems.”

This was not an idle threat. Two states have done exactly what this letter forewarned. The Louisiana law, see La. Rev. Stat. Ann. § 51:1427 and Washington State’s revised Unfair Competition Law, Wash. Rev. Code § 19.330 et seq., which are already in effect. Similar bills are pending in Arizona, Connecticut, Illinois, Kentucky, Massachusetts, New York, and Oregon. If just one more state joins this movement and passes similar laws, 20% of American states will have their own rules and regulations defining which goods violate IP or IT laws and whether they will allow those goods to be distributed within the state.

The Washington State revised law states as follows:

“SECTION 2. (1) A person may not sell, offer for sale, lease, barter, trade or exchange a product that has been produced by the person using stolen or misappropriated information technology if another person is selling, offering for sale, leasing, bartering, trading or exchanging a similar product in this state that was produced without using stolen or misappropriated information technology. The prohibition in this subsection applies regardless of whether the product is sold, offered for sale, leased, bartered, traded or exchanged individually or as a component of another product.”

On its face this amendment does not provide much. However, this is an amendment to the state’s consumer protection law. Washington State already has laws controlling punishment under consumer protection. All this amendment does expand those who can be sued under the existing law. Now foreign manufacturers and their U.S. distributors or “Product Sellers” can be sued under existing law. Since this is a complex state issue this article will rely on the Report to the Senate Committee on Labor, Commerce & Consumer Protection (Report) to analyze enforcement. Staff member Ingrid Mungia gave a very thorough analysis of the background and penalties related to this amendment. The Report is lengthy but efficiently succinct. Direct quotes from the Report will be followed by the in-line citation (Report) to clarify where public record is being cited. This “nutshell” summary looks at 5 aspects of the law.

Though Washington has a law which prohibits unfair and deceptive trade practices which directly or indirectly affect the citizens of the state, the Report directs the court not to read any list in an exclusive manner This means that lists are merely examples of the legislative intent of the law and courts are free to infer what constitutes an unfair or deceptive act without direct reference to the statute. In practice this means that companies cannot simply read the statute for a list of what does or does not violate the law. Courts are free to take jurisdiction over any act which they feel falls within the spirit of this law and potential defendants should take a broad look at their behavior. If confronted with prosecution, stating that an act is not specifically included in the statute may not likely be a successful defense. (Report)

Unique to this law is that private parties as well as the State Attorney General can bring a civil action or seek an injunction. Damages include costs, reasonable attorneys’ fees, and damages up to three times that of the actual loss, not to exceed $25,000.

The law follows the traditional rules of jurisdiction. Specifically it states that “Foreign defendants whose actions give rise to a lawsuit in a Washington court but who have never visited the state and who have no assets within Washington might not be subject to personal jurisdiction. Yet state courts may have jurisdiction to enter judgment regarding property located within the state, even if the courts do not have personal jurisdiction over that defendant.” This is called “in rem” jurisdiction, which simply means jurisdiction over property. It clarifies that though the state may not have jurisdiction over you personally, the court can take jurisdiction over any property you have in the state.

3.Staff summary of bill

As for who potential defendants will be, the staff summarize the reach of the law as follows: “A business that manufactures a product while using stolen or misappropriated information technology (stolen IT) in its business operations engages in unfair competition when the product is sold in Washington, either separately or as a component of another product, in competition with a product made without use of stolen IT. A new cause of action allows private plaintiffs or the Attorney General to sue businesses that engage in these unfair acts. Stolen or misappropriated IT is defined as hardware or software that a person acquired, appropriated, or used unlawfully, unless the hardware or software was not available for stand-alone retail purchase at or before the time it was stolen. Using information technology in business operations means using IT to design, manufacture, distribution, marketing, or sell products.”

Before filing suit a party, the plaintiff or state must provide written notice to the alleged offender. The notice must provide an opportunity for the party to prove that it is not in violation of state law or provide 90 days for the other party to cease using property in violation of the law, legalize its operations or replace the stolen IT. Plaintiffs can extend this 90 day period. The notice must identify six specific pieces of information.

(1) Which property is claimed to be in violation of the law;

(2) The lawful owner;

(3) That this specific law is the basis of the complaint;

(4) How the offending material is being used, if the party knows;

(5) Products associated with the cause of action; and

(6) Sufficient evidence and the basis for alleging the IP violation.

First, only parties that can prove an injury can bring a cause of action. This means that most private actions must be brought by competitors; an injured party. To qualify a plaintiff must prove the following four elements by a preponderance of the evidence.

l  The person manufactures articles or products sold or offered for sale in Washington in competition with articles or products made using stolen IT;

l  The person’s articles or products were not manufactured using stolen IT;

l  The person suffered economic harm, which may be shown by evidence that the retail price of the stolen IT was $20,000 or more; and

l  The person is proceeding in rem or seeks injunctive relief, that they have suffered a material competitive injury. (Report)

Second, in addition to having standing as an injured party a private plaintiff must show “material competitive injury” before a court will grant remedies, such as attachments or an injunction. Injury is measured over a four-month period and private parties must show that it is in direct competition with the product made with the use of stolen or misappropriated IP and that the private party and defendant are in direct competition. This burden appears to be reserved for private parties and the Washington Attorney General is not included in this provision. As a result private plaintiffs may turn to the AG to bring an action where it lacks sufficient evidence.

Following is a checklist of items to determine your liability. This checklist does not replace legal advice. This is merely a generalized summary of the law. The lists are not exhaustive and only an experienced IP attorney can provide adequate advice. If your answer to any of the following questions is “yes” then you should consider seeking further legal advice.

 

If your manufacturing and distribution is completely run by open-source software or legally licensed software then the answer is no. Ignorance, especially intentional ignorance, does not constitute a “no” response. The law requires all parties explicitly demand that all businesses that contribute to the final product have legally licensed software and provide for cancellation of the contract with proper notice if there is a violation. You must undertake a good-faith effort before saying “no” to the question. “Not that I know of ” does not qualify as a “no” response. This may possibly be met by using third-party auditors to review foreign sites.

 

Checklist 2: Do your products fall outside of the scope of the specific exclusions?

If a suit is brought against you and any of the following four exemptions apply to you then the case will be dismissed.

a.       Your end product sold or offered for sale in Washington is:

l  A copyrightable work under the United States Copyright Act;

l  Merchandise manufactured by or on behalf of a copyright owner and that displays a component or copyrightable element of a copyrighted work;

l  Merchandise manufactured by or on behalf of a copyright owner or trademark owner and that displays a component or copyrightable elements relating to a theme park or theme park attraction; or

l  Packaging or promotional material for such copyrightable works or merchandise.

 

b. The allegation against you is based on a claim that the IT infringes on patents or trade secrets;

c. The allegation against you is based on a claim that the use of the IT violates the terms of an open source software license; or

d. The allegation against you is that a person aided, facilitated, or otherwise assisted someone else to acquire or use stolen IT. (Report)

Checklist 3: Can you clam an affirmative defense?

There are four affirmative defenses to shield product sellers from liability. If any of the following are true then you cannot be sued.

a ) Your annua l r evenue below $50,000,000.

b) You do not have a contractual relationship with the manufacturer.

c) You have clearly established and enforced a code of conduct in practice and/or in written document (including contracts, offers, letter, emails and other communications) forbidding the manufacturer from using “stolen or misappropriated IT.” Evidence that you qualify for this defense includes proof that you have sent a copy of the law, definitions and clarify what constitutes “stolen or misappropriated IT to the manufacturer; you have clearly communicated orally or in contracts and documents that all agreements are subject to compliance with applicable laws; and you have followed up and obtained written assurances from the manufacturer that it has acted in good faith or due diligence to ensure that to the manufacturer’s reasonable knowledge the supply line is clean and no products were manufactured or acquired that were the product of stolen or misappropriated IT.

d) Within 180 days of receiving notice of a judgment against a manufacturer providing you products, you contacted the manufacturer and:

a. Obtained written further assurances confirming that the manufacturer is not using or buying “stolen or misappropriated IT” in relation to you as a Product Seller;

b. Asserted the contract right precondition forbidding the manufacturer’s use of “stolen or misappropriated IT“ and demand the manufacturer cease any and all theft or misappropriation; or

c. Asserted the right to cease any future purchases based on condition that all agreements are subject to compliance with applicable laws and state that cancellation does not constitute a breach of contract based on illegality and the preconditions of the prior Agreement.

In summary, checklist 3 indicates that product sellers must take a more active role in preventing IP violations. They must take an active role in enforcing IP compliance. Given that courts have been instructed to take a liberal view in prosecutions, a Product Seller should take a liberal view in ensuring it can do the following:

l  Provide evidence that it has acted in good faith with due diligence and reserved the right to conduct audits of manufacturers directly or through a third-party or business association.

l  Provide evidence it has taken commercially reasonable efforts to enforce practices and procedures requiring manufacturer’s exclusive use of legal IP.

l  Provide evidence it has clearly stated that if the foreign manufacturer is found in violation of IP law that the Product Seller believes this may also be a violation of the contract. The product seller should clearly reserve the right to unilaterally terminate the contract, subject to a reasonable cure period.

 

If violations continue despite the required notice, an injured person or the Attorney General may bring an injunction which may include a court order stopping all sales in Washington. A plaintiff also may seek 1) actual damages or 2) the amount of the retail price of the stolen IT, depending on which is highest. The court may triple the damages if the defendant willfully used stolen IT. A court may award costs and reasonable attorneys’ fees to the prevailing party for all litigation expenses incurred in actions brought by an injured person.

 

It does not state the grounds for treble damages; however this is an amendment which will have a wealth of statutory and case law citations in place under the existing consumer protection law. As noted above, treble damages are reserved for the most egregious of offenders that display a willful violation of the law.

 

The plaintiff may add a third party defendant if a court has first entered judgment against the person using stolen IT, presumably a violating manufacturer. Five issues must be considered before seeking damages from a third party.

 

1) Ensure that the third party was served the same notice as violating manufacturer 90 days or more before the judgment was entered; 2) The third party is only liable if the manufacturer cannot satisfy the judgment; 3) The third party must be responsible for providing 30% of the end product or component produced by the violating manufacturer; 4) The third party had a direct contractual relationship with the violating manufacturer; and 5) The third party is not already facing or has faced litigation for the same action.

 

Damages against a third party are limited to the retail price of the stolen IT, minus compensation received from the person using stolen IP and cannot exceed $250,000. The court may award attorneys’ fees to a third party who qualifies for an affirmative defense, however the third party must provide notice to the plaintiff of the affirmative defense before being added to the action. There is an 18 month statute of limitations on enforcing an award of damages against a third party.

 

A third party can avoid damages if it can establish that:

l  It acquired the product after its sale to an end consumer or is an end consumer of a product or;

l  It has annual revenues of less than $50 million;

l  It reasonably relied on the manufacturer’s code of conduct governing commercial relationships or implemented its own commercially reasonably efforts and a code of conduct with its manufacturer forbidding the use of misappropriated or stolen it; or

l  It has no contractual relationship with the violating manufacturer.

As noted, this is merely a summary of the law and public record. If any of these issues are potentially related to your business you are strongly advised to seek counsel experienced with Washington state law.

 

The purpose of the preceding material was to outline the Washington state law.

The overall message here is to show how complicated this is. If this trend continues, a similar analysis will be required for every state that passes a similar law. This author’s hope is that there will be two responses. First, parties should realize the importance of ensuring they have clean IP operations, including third parties. Second, manufactures and law firms that advise manufacturers must realize they can no longer focus exclusively on U.S. federal law when doing business with the U.S. They must have legal departments capable of tracking U.S. law at the state level. The list of states will continue to grow. Distribution in the U.S. could become a maze of conflicting IP regimes. Affected parties in China should begin to make changes in their legal departments now while this movement is in its infancy.