Cannata and Misiti issue Bulletin entitled, “No Coverage For The Sale Of Counterfeit Goods”

June 6, 2016 | Insurance Coverage | Intellectual Property

Businesses that peddle counterfeit goods beware.  According to a recent decision by the Second Circuit, the advertising injury provisions of a standard general liability policy do not obligate an insurer to indemnify its insured for damages resulting from the insured’s sale of counterfeit goods.  Given that the MSRP for all goods seized by the Department of Homeland Security in Fiscal Year 2014 was in excess of $1.2 billion (had the goods been genuine), the decision by the Second Circuit in United States Fid. & Guar. Co. v. Fendi Adele S.R.L., 2016 U.S. App. Lexis 8973 (May 17, 2016), is of paramount importance to businesses and insurers alike.

In January 2006, Fendi – – the famed Italian designer – – filed suit against Ashley Reed (“Reed”) claiming that Reed violated the Lanham Act by intentionally using certain trademarks owned by Fendi in connection with Reed’s sale of counterfeit goods.  After an initial appeal to the Second Circuit regarding the amount of damages, the District Court entered judgment against Reed for $34,650,885.91 representing Reed’s sales of counterfeit goods, trebled, and attorneys’ fees and costs.

Likewise, in January 2006, Fendi separately sued Burlington Coat Factory Warehouse Corp. (“Burlington”), an entity that re-sold, at the retail level, Fendi counterfeit goods purchased from Reed.  Burlington, in turn, filed a third-party complaint against Reed.  Judgment was ultimately entered against Reed on the third-party complaint in the amount of $248,257.14, the amount of profits generated by Burlington from the sale of the counterfeit goods, as well as, attorneys’ fees, costs, and interest.

In January 2011, U.S. Fidelity & Guaranty Company (“USF&G”), which had been providing a defense to Reed in the Fendi action, subject to a reservation of rights, commenced a declaratory judgment action against Reed and Fendi.  Burlington subsequently intervened in that action.  Cross-motions for summary judgment followed and the district court granted USF&G’s motion for summary judgment finding that it did not have any obligation to indemnify Reed because Reed’s liability did not arise out of the advertising of counterfeit goods, but rather the sale of counterfeit goods.  An appeal to the Second Circuit followed.

The Second Circuit affirmed the district court’s decision, likewise, concluding that the injuries sustained by Reed did not arise from its advertising activities, but, instead, arose from Reed’s sale of the counterfeit Fendi products.

At issue in this matter were two USF&G liability policies issued to Reed.  Both of the policies provided coverage for damages because of advertising injury.  The policies defined “advertising” as “attracting the attention of others by any means for the purpose of seeking customers or supporters or increasing sales or business.”  The definition of “advertising injury” included the offenses of: (i) “the use of another’s advertising idea in your ‘advertising’”; and (ii) “infringement of another’s copyright, trade dress or slogan in your ‘advertising.’”

The Second Circuit, relying on authority from the New York Court of Appeals, stated that for advertising injury to be covered, it must be an enumerated offense listed in the policy that occurred in the course of an insured’s advertising activity.  The Court, after examining the facts in the underlying case, concluded that Reed did not engage in any advertising of the counterfeit goods, nor did Fendi suffer any injury because of advertising activities undertaken by Reed.  Rather, Fendi’s damages were based on the sale of the counterfeit products.

The Second Circuit rejected arguments by Fendi and Burlington that the use of the Fendi mark constituted advertising injury because the mark was used to attract the attention of others for the purpose of seeking customers and increasing sales.  The Court noted that the policies must be construed based on common speech and the reasonable expectations of a business person.  The court held that the parties “could not have reasonably expected that the advertising injury coverage . . . would extend to the insured’s sale of infringing goods (where the insured engaged in no advertising of the counterfeit goods) or that ‘advertising’ would include the sale (without more) of counterfeit products.”

The Court highlighted the difference between placement of a counterfeit brand label on a product versus the act of soliciting customers through printed advertisements or other media, and found that the Fendi logo here was used for product identification, not advertisement.  The Court concluded that USF&G had no obligation to indemnify Reed for the damages awarded in the underlying actions.

Lastly, the Court noted that the claims alleged in these actions would also be barred from coverage based on the knowledge of falsity exclusion.  This exclusion bars coverage for advertising injury “arising out of oral or written publication of material, if done by or at the direction of the insured with knowledge of its falsity.”  This exclusion would be applicable – – if there was a claim for advertising injury – – because Reed’s use of the Fendi logo on its handbags was done with knowledge that it was selling goods bearing a false designation of origin.

This Second Circuit decision highlights the fact that insurers will not be obligated to indemnify businesses – – under coverage provided for advertising injury – – for damages that result solely out of the practice of peddling counterfeit goods.

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