Supreme Court to Hear Case on Unintentional Use of Counterfeit Parts

Updated: Mar 12

On January 14, the Supreme Court will hear a case on a minute point of IP law: whether plaintiffs must show “willful” trademark infringement to get an order requiring the infringer to disgorge its profits. This legal dispute seems arcane, but it could create massive new forms of liability for companies with long supply chains, especially those that reach back into China. If the Supreme Court finds for petitioner in Romag Fasteners v. Fossil, Inc., those companies may be facing huge damages awards for using counterfeit parts—even if they didn’t intend to, and even if the components are just a small piece of the product.

Legal Precedent

Prior to 1999, the law was clear: a plaintiff had to show that infringement was willful—i.e., that the defendant deliberately set out to infringe a trademark, or recklessly stuck its head in the sand about infringement—if it sought “disgorgement” of the profits resulting from infringement. This was a high standard to meet. But courts reasoned that it was unfair to impose huge liability on a company because some distant supplier had infringed on someone else’s trademark. Otherwise, companies would be required to investigate every step in their lengthy supply chains, or run the risk of having their profits for entire product lines seized because one supplier among many was infringing.

Under this framework, Fossil, a well-known retailer of luxury clothing and goods, had done everything right. The retailer licensed the manufacture of its handbags to a Chinese manufacturer, which bought its components from Chinese suppliers. Aware that counterfeit goods are ubiquitous in China, Fossil sent inspectors to drop in unannounced at contractors who supplied major components like treated leather and zippers. But it overlooked one tiny part: the magnetic fasteners used in many of its handbags’ clasps. The patent and trademark holder of these fasteners is Romag Fasteners, an American company, which licenses their manufacture to Wing Yip Ltd., a Chinese company. Romag was paid five cents for each fastener Wang Yip sold.

Unknown to Fossil, its Chinese manufacturer was buying counterfeit fasteners and pocketing the difference. In May 2010, Romag caught on to scheme. Nonetheless, the company sat on its discovery for several months, until the week of Black Friday, when it had maximum leverage over Fossil. Just before the busiest shopping day of the year, Romag filed suit seeking an injunction for trademark infringement, recall of all Fossil handbags containing counterfeit fasteners, and disgorgement of Fossil’s profits.

District Court Ruling

A district court in Connecticut issued a restraining order, and Fossil was forced to recall more than $4 million of bags during the Christmas shopping season. A jury later found that the fasteners were counterfeit and awarded Romag a “reasonable royalty” of nine cents for each (nearly twice what the company was paid for legitimate fasteners), amounting to about $66,000. But the jury also ordered Fossil to disgorge $6.7 million in profits to Romag—all of the profits from the bags, even though there was no evidence that Fossil knew about or intended the counterfeiting.

The district court, applying the well-established principle that you only get an award of profits for intentional infringement, reversed the jury’s $6.7 million award, and the appeals court affirmed. So many observers were surprised when the Supreme Court decided to review the case. It appears the Court is responding to a wrinkle in the Lanham Act, the statute governing trademarks. Until 1999, the Act stated that profits could only be awarded for infringement when “principles of equity” required it. Courts almost unanimously interpreted this to mean that a defendant had to intend to infringe, or be reckless as to the likelihood of infringement. But in 1999, Congress amended the Act to add a cause of action for “trademark dilution,” and explicitly stated that a plaintiff had to show willful infringement to get an award of profits for this new dilution claim.

Romag’s argument is that Congress is deliberate about its statutory choices. If Congress requires willfulness to get an award of profits on a dilution claim but doesn’t say anything about intent when it comes to a regular infringement claim, it must have intended that choice. This is the kind of close textual reading that may well be persuasive to an increasingly formalistic Supreme Court. But it ignores the long and nearly unanimous history of courts requiring plaintiffs to show something more than unintentional infringement to get disgorgement of profits.

This argument also ignores the realities of disparate, global supply chains, and especially the tidal wave of counterfeit Chinese goods. A 2013 report from the United Nations found that 87 percent of counterfeit goods seized in the U.S. came from China. The value of counterfeit goods shipped here from China is thought to exceed $25 billion annually. Globally, more than 2 percent of all consumer goods are counterfeit. Given the ubiquity of counterfeit goods and the way they can insinuate themselves into supply chains, every company that buys components from, or manufactures products in China is at serious risk of unintentional infringement.

Current IP Laws

Current IP law allows companies to get royalties for infringement of their marks, like the nine cents per fastener Romag was awarded. But permitting plaintiffs to take all of company’s profit for counterfeit components—even if infringement was unintentional, even if the component constitutes a tiny fraction of the entire product—puts a powerful new weapon in the hands of mark holders. As a group of IP professors wrote in a friend of the Court brief, a victory for Romag would “unjustly enrich plaintiffs and disproportionately punish defendants with awards that far exceed any measure of the actual damages” from infringement, and “would create strong and perverse incentives for plaintiffs to engage in strategic and abusive litigation practices that would have far more to do with leveraging … costly settlements.”

As Fossil’s experience shows, even companies that go out of their way to ensure supply chain integrity can be caught short by counterfeit components. If the Court decides for Romag, companies will be forced to go to extraordinary lengths to police their supply chain. Otherwise, they face the very real possibility of being forced to disgorge their profits if even small components in their products are infringing. For many companies, this risk of massive liability simply won’t be worth the cost.

A decision is expected by June.

Read about Carpenter Wellington’s general counsel and intellectual property practices.