Counterfeit Products Present Additional Business Risks for Distributors and Contractors

Executive Summary: Manufacturers, distributors, and electrical contractors build enduring relationships by supplying quality, dependable electrical products that they are all prepared to stand behind. The introduction of counterfeit electrical products into the marketplace alters that relationship substantially. It places the distributor or contractor in a risky legal position that could leave the distributor or contractor solely responsible for defects or problems with the product. Furthermore, because a counterfeit product damages the reputation of those who trade in these products, it can dissolve the supply relationship with the genuine manufacturer.

An email from a previously unknown source traverses the Pacific Ocean to an electrical distributor in the Americas. “We would be pleased to meet you on your next visit to our country,” the email begins. “We will present our new products and promote some bargains in good price.” Attached to the email are photos of electrical products the sender indicates his company can supply: lighting products, conduit fittings, outlet boxes, circuit breakers, and receptacles. Some of the photos show products that look identical to well-known North American and European branded products, and in a couple of the pictures you can actually see the registered trademark of a well-known brand on the product or packaging. The email is enticing with the offer of “bargains in good price,” but it may be the beginning of a slippery slope for the electrical distributor not attentive to risks he has not previously experienced.

Counterfeiting is a growing global problem in the electrical sector. It is a problem with multiple dimensions: intellectual property theft, loss of tax revenue to governments, consumer deception, and threats to the health and safety of consumers. Electrical products, like pharmaceuticals, auto parts, and a few other products uniquely present all four dimensions of the counterfeiting problem, particularly the threat to consumer health and safety. Over the past two years, the National Electrical Manufacturers Association has been collecting both public and private reports about counterfeit electrical products posing a threat to public safety. A few illustrative examples include: conduit fittings installed in a hazardous location, marked with brand and certification marks bearing the manufacturer’s part number of a product designed for use in hazardous locations, but not meeting the design requirements suitable for hazardous locations; circuit breakers bearing a brand name that do not provide protection; defective control relays bearing a counterfeit certification mark that cause a machine to malfunction; extension cords bearing a brand name and certification mark for a product designed for 12 gauge wire, but actually employing a smaller 24 gauge wire that would catch on fire when the cords are used as intended; infringing imported dry cell batteries containing mercury, where U.S. law prohibits the sale of such products containing mercury.

If a defective or substandard counterfeit component is inside a product, it is not likely to be visible. For example, hair clippers containing counterfeit fuses with fake brand name and certification marks were recently seized in England. A recent Business Week article commented, “Many fakes are getting so good that even company execs say it takes a forensic scientist to distinguish them from the real McCoy.” The counterfeiters are getting very good at making molded products that look just like the genuine branded product, and on the surface it looks like a product well-known to the marketplace. One circuit breaker manufacturer has reported that sometimes one way to detect the fake from the genuine without opening up the breaker is the weight, because the inside is not built to standard, or sometimes the color of the molded plastic acts as a signal that something is not the same.

Distributors of electrical products and electrical contractors are at risk with these products, and more so than they would be with genuine products. Where the product does not perform as expected or it causes personal injury or property damage, victims typically file breach of warranty or product liability claims. These legal claims are actionable against everyone in the chain of distribution of the product including retailers, wholesalers, distributors, contractors, and manufacturers. If a manufacturer can show, in the case of the counterfeit product, that it is not the supplier of the defective product, the manufacturer has no liability. That is because these legal claims are recognized only against the actual supplier of the product.

The “black letter” law is that “one who is engaged in the business of selling or otherwise distributing products who sells or distributes a defective product is subject to liability for harm to persons or property caused by the defect.” In 1977, a federal court of appeals in St. Louis affirmed a defense jury verdict for a manufacturer of swimming pool slides, whose defense was that the slide that caused the plaintiff’s injury was counterfeit and not made or sold by the defendant. Mere exploitation of another’s intellectual property does not make the owner of the intellectual property liable for personal injuries caused by products made by others. In 1996, the Texas Supreme Court was faced with a claim against Firestone Tire arising out of a defective automobile wheel claim. Firestone did not make or sell the wheel; however, Firestone did patent and license a specific design feature for wheels that was used in the supplier’s wheel. While the evidence showed that the supplier modified Firestone’s original design, the Texas Supreme Court held that Firestone would have to be an integral part, not just an incidental part of the overall marketing of the product. Firestone would not be liable to the claimant merely because its intellectual property was used by the product seller and the claim was dismissed.

A July 2004 ruling by a federal court judge in New York illustrates the potential liabilities for a distributor and retailer who purchase goods in the so-called gray market. This case is groundbreaking in its attempt to hold a distributor liable for purchasing medicine from sources other than a drug manufacturer. The plaintiff had a liver transplant and was prescribed Epogen in connection with post-operative recovery. Epogen is made by Amgen. The plaintiff purchased counterfeit Epogen from ProCare Pharmacy, a subsidiary of CVS, which sells and delivers prescription drugs to customers by mail. AmerisourceBergen (ABC), one of the largest prescription drug wholesaler distributors, is an authorized distributor of Epogen. According to the complaint, ABC purchased counterfeit Epogen from “secondary sources” in the “gray market,” and sold it to the pharmacy. The pharmacy in turn sold it to the plaintiff. It turns out that the counterfeit product contained 1/20th of the active ingredient that Amgen normally includes. Even though Amgen was the initial source of the active ingredient, Amgen did not sell the product that the plaintiff purchased. The federal court dismissed the manufacturer, Amgen, from the proceeding. Even though it is unknown who introduced the counterfeit drug into the distribution channel, the court upheld certain claims against the wholesaler, ABC, and the retailer CVS. One of the factors the court considered in deciding to allow the claim against the wholesaler to proceed was the allegation that ABC had distributed drugs in a way as to proliferate a “gray market” that permitted trade in diverted and counterfeit drugs thereby contributing to the problem. Also, ABC was probably in the best position in the distribution chain to protect against counterfeit drugs by simply purchasing directly from the drug manufacturer instead of purchasing deeply discounted and suspicious drugs in the gray market.

This leaves the distributor and possibly the electrical contractor or a retailer as the only parties to whom the claimant can look to seek compensation, and seeking indemnity from the manufacturer of the counterfeit product is highly problematic. For example, the email communication cited at the beginning of this article came not from a product manufacturer but a trading house, one of many that are competing for orders across Asia. The trading house does not always reveal its supply sources and therefore the identity of the manufacturer may never be known. Even if the foreign manufacturer is known, getting jurisdiction over the foreign manufacturer in an American court is problematic, litigating overseas brings its own set of problems, and even if an indemnity judgment is obtained from the overseas source, enforcing and collecting on the judgment is not easy.

Product liability and warranty law does not present the only legal risk for distributors in these circumstances. Intellectual property law also imposes a different layer of liability and provides remedies to a different category of claimant: the owner of the intellectual property. In general, goods that infringe the rights of United States trademark owners are not permitted importation; infringing goods are subject to seizure and forfeiture by the Customs Service. Under Customs’ laws and regulations, goods that infringe upon rights of trademark owners are classified into two categories. The first category consists of counterfeit merchandise that bears “a spurious mark which is identical with, or substantially indistinguishable from, a registered mark.” Usually, “counterfeit merchandise is made so as to imitate a well-known product in all details of construction and appearance so as to deceive customers into thinking that they are getting genuine merchandise.” The second category consists of “merely infringing” goods which are not counterfeits but bear marks likely to cause public confusion. This category includes merchandise which bears a mark that “copies or simulates” a registered mark so as to be likely to cause the public to associate the copying or simulating mark with the registered mark. The significance of the distinction between counterfeits and merely infringing goods lies in the consequences attached to the two categories. Counterfeits must be seized, and in the absence of the written consent of the trademark owner, forfeited. Merely infringing goods, on the other hand, may be seized and forfeited for violating. Under Customs regulations, merely infringing goods may be imported if the “objectionable mark is removed or obliterated prior to importation in such a manner as to be illegible and incapable of being reconstituted.” The line between counterfeit and “merely infringing” is not a bright line. While a counterfeit trademark will always include identical trademarks, they may include very close simulations. Recently when enforcing Callaway Golf’s Big Bertha trademark for drivers, U.S. Customs treated imported “Big Boomer” drivers as counterfeit, rather than merely infringing and seized and destroyed the product. The importing distributor lost his entire investment in the illegal product.

A foreign manufacturer could be held liable for direct infringement of a United States patent for selling an infringing product abroad that later gets imported in the United States. Active inducement of infringement occurs when a foreign manufacturer does not itself import and sell the infringing products, but has a distribution agreement with an importer. Such a distribution agreement may show the necessary intent by a foreign manufacturer “to invade the United States market at a time when [the manufacturer] was fully aware of [the patentee’s] United States patents.” U.S. patent law also imposes liability on a distributor who has aided or abetted another’s direct infringement. This is based on a theory of joint tortfeasance, where one who intentionally causes another to commit a tort is jointly and severally liable with the primary tortfeasor.

Even where the product sourced bears no counterfeit trademark or certification mark, there is the potential risk that a foreign supplier who makes a “look alike” product has copied patented technology and incorporated it inside the product. Patent holders are not without their remedies in these circumstances, although the nature of a distributor’s liability can be affected by whether they knowingly infringed. Distributors frequently endeavor to limit their liability in such cases by asking suppliers to provide a warranty of title and indemnity against non-infringement; however, in the case of foreign-sourced products the distributor faces the problem of legal enforcement discussed above.

For example, in China, there are few difficulties in taking IP enforcement actions against infringers so long as it is registered in China and the IP owner procures the action. Although such actions, which typically take as long as a year in the Chinese courts, will eventually shut down the counterfeiter, it is not a sufficient deterrent due to the lack of criminal penalties. A less expensive alternative to the Chinese courts is an administrative action in China; however such actions usually result in seizure and destruction of the product and lack sufficient deterrent penalties.

What can distributors and contractors do to avoid these risks? Recommendations made by Consumer Reports in their November 2004 issue for consumers are equally applicable to the electrical distribution channel:

  • Be cautious of extraordinary bargains. Products may be cheap because they are counterfeit or defective.
  • Beware of products sold outside the normal distribution channel. It is difficult to collect from fly-by-night vendors.
  • Check the warning label. Be cautious where the label conflicts with information elsewhere on the package or is written in ungrammatical English.
  • Avoid purchasing no-name products. Knowing the name of the manufacturer allows authorities to track down a legitimate corporation to remedy problems.
  • If you have concerns about the authenticity of a certification mark, call the certifier.

Additionally, the distributor or electrical contractor might notice differences in packaging, product coloration, weight, and other product characteristics that they are not familiar with, and they should contact the manufacturer to determine if the differences represent product design changes. Distributors and contractors should be alert to old dates on packaging that might signal that a previous version of the packaging no longer used by the genuine manufacturer was copied by the counterfeiter. Other business strategies include doing business with a trading partner that has been around for awhile, calling manufacturers directly about suspect parts or independently testing products, and purchasing from distributors who carefully screen, certify suppliers and guarantee a refund if the part turns out to be counterfeit.

Trade secrets and advanced monitoring technology in the distribution channels may decrease the counterfeits. For example, pharmaceutical drugs such as Viagra and OxyCotin will be electronically tagged with radio-frequency identification technology within the next year. This will make it more difficult to introduce counterfeit medicines in the supply chain from the manufacturer to the check out counter. Another example is Nokia, who recently faced scrutiny for purchasing counterfeit batteries that resulted in exploding batteries. In response, Nokia decided to label its original batteries with a special holographic image and authentication code to stem the sale of unsafe, low quality products.

Finally, the difficulties of seeking legal redress from foreign suppliers who have no domestic presence are an issue that applies to both counterfeit or infringing products and genuine products. Manufacturers who establish joint ventures and supply relationships with overseas vendors typically engage in an extensive due diligence analysis of their prospective partner or supplier, including whether there is a history of intellectual property infringement and whether the partner or supplier will also shoulder a product manufacturing risk. Distributors, electrical contractors and retailers should not overlook the normal due diligence that attends to any business transaction in deciding whether to choose between a familiar source of supply or a new overseas vendor.

Counterfeit products injure the reputation of manufacturers, distributors and contractors. Selling items bearing counterfeit marks defrauds contractors and distributors who pay for brand-name merchandise but bring home low quality fakes. It cheats manufacturers out of legitimate sales and tarnishes their reputation when they are blamed for the poor quality of the counterfeit merchandise. Even high quality counterfeits hurt legitimate manufacturers by artificially inflating market supply and lowering demand and sales. It also injures legitimate distributors and contractors who must provide refunds to customers who discover that their brand-name goods are, in fact, counterfeit.