In this article, our trade marks solicitors explain the principle of exhaustion of intellectual property rights, when exhaustion occurs and when it does not. We discuss how exhaustion operates in relation to parallel imports, and the potential impact of parallel trade on your business. Finally, we consider the steps you can take to control your goods once they are on the open market to protect your brand.
Contents:
- What is meant by the exhaustion of intellectual property rights?
- What are parallel imports?
- Are there any exceptions to the exhaustion of intellectual property rights?
- Can exhaustion apply to digital goods and online content?
- What are the different types of exhaustion and how do they differ?
- How does the exhaustion of intellectual property rights affect the ability to control parallel imports?
- What is the impact of parallel imports on intellectual property rights owners?
- How does the exhaustion of intellectual property rights affect the pricing strategies of companies?
- What can intellectual property rights holders do to limit the impact of parallel imports?
- Summary
What is meant by the exhaustion of intellectual property rights?
Exhaustion of intellectual property rights is a fundamental principle of intellectual property law. It governs the extent to which a brand owner can control the distribution of genuine products, which are those that are produced or authorised by the brand owner. As a general rule, the exhaustion principle states that once you have sold genuine goods, your rights over them are exhausted. You cannot object to or claim a profit on any subsequent sale of the goods and have no right to sue for infringement. Exhaustion applies only to genuine goods and not infringing ones manufactured and put on the market without your consent.
What are parallel imports?
Parallel imports are goods intended by the brand owner to be sold in one part of the world but imported by third parties to other countries without the brand owner’s consent. In essence, parallel imports run ‘parallel’ to a brand owner’s authorised distribution channels.
The issue for a consumer when purchasing a parallel import is not the legitimacy of the product itself since it is genuine. It is that products bought outside the brand owner’s authorised channels are unlikely to be covered by warranties, so the consumer may have little recourse if things go wrong. Since many parallel imports are expensive items, this lack of protection can have severe consequences.
Are there any exceptions to the exhaustion of intellectual property rights?
There is one key exception to the exhaustion of intellectual property rights: Trade mark and patent owners can object to further dealings with their goods once sold if they have ‘legitimate reasons’ for their objection, particularly if the goods’ condition has been altered since they were first put on the market.
This exception begs the question of what might be classed as ‘legitimate reasons’ for a trade mark and patent owner to object. For trade marks, the Courts permit a trade mark owner to object to the resale of genuine goods if the reseller’s actions seriously harm the trade mark’s reputation. Whilst this objection is likely to be most applicable to luxury brands, it can be invoked by any brand owner concerned about their reputation. The bar is fairly high, and the Court will consider each case on its facts. Our intellectual property solicitors will review the circumstances of your case and advise on whether your concerns might constitute ‘legitimate reasons’.
Can exhaustion apply to digital goods and online content?
It is pretty easy to see how exhaustion applies to physical goods, but how does this apply to digital goods and online content, such as the download of a song or eBook?
In a case involving eBooks, the Court of Justice of the European Union decided that exhaustion did not apply to digital media like eBooks. As a result, if you resell a used eBook without the copyright owner’s permission, you may infringe copyright. Part of the Court’s reasoning for the decision was that, unlike tangible goods, which deteriorate over time, digital media remains in a mint condition, so it offers an exact substitute for original goods, often at a far cheaper price. There is little difference between the primary and second-hand markets, meaning such activity is likely to have a more significant impact on the rights owner’s business than the resale of tangible goods. A notable exception to the general rule that there is no such thing as ‘digital exhaustion’ is in relation to software. Reselling user licences for software is generally allowed provided several conditions are met, including that the seller ensures the initial copy is unusable.
What are the different types of exhaustion and how do they differ?
Unfortunately, exhaustion has not been harmonised across different jurisdictions, and countries operate different exhaustion principles. Most countries operate either a national or international exhaustion regime. We give an overview of these two regimes below.
National
Under a national exhaustion regime, the rights owner’s rights are exhausted when they put the goods for sale on the domestic market. National exhaustion generally favours the rights owner since they can prevent parallel imports from other countries. Examples of countries that operate national exhaustion regimes include Tunisia, Ghana, and Morocco.
International
Under an international exhaustion regime, the right owner’s ability to control their goods is exhausted when they are placed on the market anywhere in the world. Genuine goods put on the market with the brand owner’s consent can be imported into a country that operates an international exhaustion regime without infringing the brand owner’s rights. International exhaustion generally favours the consumer. Examples of countries that operate international exhaustion regimes include India, China, and Australia.
The position in the UK is known as territorial exhaustion. Putting goods on the market in the UK or EEA (European Economic Area) exhausts the rights owner’s right in the UK. Putting goods on the market anywhere else in the world does not exhaust the right’s owner’s rights in the UK. On the other hand, goods first placed on the UK market and then exported into the EEA may infringe a brand owner’s EU rights. So, you may need permission to export goods from the UK to the EEA. Speak to us if you are unsure. We will review your situation and advise on your rights and responsibilities.
How does the exhaustion of intellectual property rights affect the ability to control parallel imports?
An effective brand protection strategy is crucial to the success of your business. When the goods causing issues are infringing, you have an array of weapons in your armoury, including sending a formal legal letter, negotiation, and litigation. The issue is significantly more complicated when the goods in question are genuine. When your intellectual property rights have been exhausted, you effectively lose control of the goods and cannot regulate what third parties do with them.
What is the impact of parallel imports on intellectual property rights owners?
Parallel imports can be a real headache for brand owners. Examples of the issues they can cause include the following:
- Loss of control. Since parallel importers operate independently of you and your authorised distribution channels, the goods are not subject to the pricing strategies, quality control and other matters relevant in the country to which they are imported.
- Quality differences. Brand owners sometimes create varying quality goods for different countries in response to a perceived preference amongst consumers. In extreme cases, goods that may be safe in one country might not be in another. If the parallel imports are of a lesser quality than those produced specifically for that market, or cause harm to consumers, your reputation may be tarnished despite you not being at fault.
- Impact on your supply chain. Your relationship with licensees and distributors may be affected if third parties sell the same goods within their territory, particularly if the parallel imports are cheaper than those offered by the distributor.
- Brand dilution. To protect the integrity of their brand, many brand owners operate strict conditions relating to where and how their products can be sold. When the goods are parallel imports, you cannot exercise such control. For example, luxury brands may end up being sold in discount retailers, tarnishing the brand’s reputation.
- Reduced profitability. When a market becomes flooded with parallel imports, the potential impact on your profitability is clear.
- Disrupted marketing strategies. Brand owners often launch new products on a piecemeal basis across different countries. When parallel imports are introduced into a market before the brand officially launches the product there, the business’s marketing strategy can be significantly undermined.
How does the exhaustion of intellectual property rights affect the pricing strategies of companies?
Exhaustion of intellectual property rights can have far-reaching consequences for a brand owner’s pricing strategies, including the following:
- Many businesses operate a price discrimination policy, effectively charging consumers different prices for the same goods based on their needs, expectations, and spending power. To obtain global visibility, brand owners are sometimes incentivised to supply consumers in low-income countries with a product for a much lower price than that charged to consumers in more affluent territories. If the type of exhaustion applicable in the relevant country (namely, international exhaustion) allows the domestic market to be flooded with parallel imports initially put on the market in low-income countries, the business may need to rethink its pricing strategy.
- Market forces and supply and demand are key factors in deciding a price strategy. When you operate internationally, government price controls also play an important role. Different countries’ governments operate different price controls that can lead to significant and persistent price differentials between territories, particularly in the pharmaceutical industry. Parallel importers often exploit the discrepancy by importing goods from a country in which the goods are subject to a price cap into one where they are not. When deciding on a global pricing strategy, you need to consider the potential impact of parallel imports.
What can intellectual property rights holders do to limit the impact of parallel imports?
Whilst addressing the problem of parallel imports can be difficult, there are steps you can take to limit their impact on your brand. They include the following:
Ensure your contracts are watertight
You should review your distribution agreements to ensure they effectively deter parallel imports. The agreements should clearly define the territory in which each distributor is entitled to sell and prohibit them from selling outside their designated area. You should include terms specifically addressing the consequences of a distributor parallel importing, which may include terminating the agreement and the distributor having to pay pre-agreed damages. The agreement should also clearly detail how any leftover stock should be dealt with to ensure it cannot make its way back onto the market.
Our intellectual property solicitors have extensive experience in drafting effective, watertight distribution and other supply chain agreements. If you have contracts already in place, they will review them and suggest any amendments necessary to address the issue of parallel imports.
Incentivise consumers
A practical step to reduce the impact of parallel imports is to incentivise consumers to purchase goods through official channels. Examples of the types of measures businesses sometimes implement include offering loyalty schemes, providing country-specific guarantees, and delivering an enhanced level of customer service with respect to goods purchased through authorised channels.
Enforcing your rights
Whilst the principle of exhaustion can prevent you from controlling genuine goods once you have placed them on the market, it does not negate your intellectual property rights in general. If the activities infringe your intellectual property rights, you can intervene. For example, if a parallel importer sells goods online through a website using your trade mark, you can rely on your registered trade mark to take the website down.
Monitoring
Ongoing monitoring, both of your supply chain and your brand in general can help flag any potential parallel imports.
You should put measures in place that enable you to trace your goods through the entire supply chain. That way, if goods turn up in a country they weren’t intended for, you can easily identify where they came from and take action against the distributor. The types of measures that can assist in achieving an effective track and trace system include designing distinctive product design and packaging for different countries, using territory-specific bar codes, and ensuring the goods feature labels stating the markets they are authorised for. Such measures are often instrumental in deterring any distributor tempted to parallel import.
Various software systems can assist in monitoring your brand and alerting you to any parallel imports. Since price discrepancies are often a red flag for parallel imports, one of the main tasks performed by the software is scanning the internet for any products being sold at a significantly lower price than usual and highlighting them for further investigation.
Working with customs
Whilst parallel imports are often lawful, they can easily tip over into the realm of infringement if your rights have not been exhausted. Since you can ask customs authorities in the relevant countries to seize and inspect any goods you suspect of infringing your rights, working with customs is a convenient way through which to monitor both infringements and parallel imports. If the goods are, indeed, unlawful, you can take action against the infringer and prevent the goods from entering the market.
Our intellectual property solicitors regularly work with border authorities to monitor the movement of our clients’ goods and ensure any infringements are addressed swiftly.
Summary
Exhaustion is a fundamental principle of intellectual property law, placing necessary limits on a rights holder’s ability to control goods placed on the open market. Its impact in the context of parallel imports is a topic of hot debate. On the one hand, parallel trade is often praised for facilitating competition and offering consumers a wider choice and cheaper goods. On the other hand, parallel imports can have disastrous consequences on a business’s commercial operations, profitability and reputation. They can affect your pricing strategy, thwart global marketing campaigns, and cause issues with your authorised supply chain. Whilst you may be unable to prevent parallel imports entirely, it is vital to implement proactive measures to address the issue and mitigate its impact. Where necessary, our intellectual property specialists will factor the potential for parallel imports into your overall brand protection strategy, putting the appropriate contractual documentation and monitoring systems in place and taking any and all action required to protect your interests.
