Payment Service Providers May Be Liable for Counterfeit Website Sales–Gucci v. Frontline

By Eric Goldman

Gucci America, Inc. v. Frontline Processing Corp., 2010 WL 2541367 (S.D.N.Y. June 23, 2010)

This case relates to an online seller of Gucci counterfeit goods called TheBagAddiction.com, run by Laurette. Gucci already successfully shut down the counterfeit website, but it remains on the warpath, looking to nail more defendants. It has sued three additional companies, Durango, Frontline and Woodforest. Durango helps hard-to-service merchants such as TheBagAddiction and other sellers of “replica products” find payment service providers. Frontline and Woodforest are both payment service providers that service Visa, Mastercard and AmEx (Frontline also services Discover). Thus, in this action, Gucci is chasing the payment service providers who helped the counterfeit site get paid. In this respect, the case is analogous to Perfect 10’s suits against ccBill and Visa, except that Gucci is proceeding on a trademark claim and not copyright.

In this ruling, the court says that Gucci’s contributory trademark claims survive the defendants’ motion to dismiss. The court dismisses the direct and vicarious trademark claims.

The court says that Durango, the matchmaker/finder, could be liable on an inducement theory because it advertised its services as finding payment services for “high risk” merchants such as those selling “replica” merchandise. Gucci is basically taking the realpolitik position that everyone knows that high-risk merchants selling replicas are just counterfeiters and so Durango should be brought to justice for assisting that retailer niche. Gucci also alleges that Durango encouraged merchants to reduce chargebacks by including a checkbox on the consumer checkout screen saying that they acknowledged they were buying replicas. Although the checkbox didn’t help Durango here, I wonder what it will do to the underlying questions of consumer confusion about product source.

In contrast, Frontline and Woodforest didn’t induce because “they did not bring [the website] to the table the way Durango allegedly did.” While that’s true, I’m not clear about the line the judge is drawing.

The court instead evaluates Frontline’s and Woodforest’s contributory trademark liability (as well as Durango’s) under the following legal standard: “if it supplied services with knowledge or by willfully shutting its eyes to the infringing conduct, while it had sufficient control over the instrumentality used to infringe.” This appears to be a further bastardization of the loosely-drafted and gratuitous language in Tiffany v. eBay about “willful blindness.” As I wrote in my post about the Tiffany ruling, “I expect plaintiffs to get frisky with this ‘willful blindness’ toy and start asserting that defendants had ‘reason to suspect’ user infringement and ‘ignored that fact.'” This case appears to be an example of that friskiness.

Gucci’s allegations against Durango satisfied the scienter requirement because:

Durango allegedly held itself out to high risk replica merchants. Its sales agent, Counley, traded emails with the Laurette Counterfeiters who expressly told him that they were unable to get credit card services because they sold “replica” items. Counley later wrote back to say he had found a U.S. bank that “can do replica accounts now.” Surely, a connection between an inability to get the services needed to transact goods online and the sale of replicas should have attracted Durango’s attention.

[note: throughout this post, I have removed some citations from the blockquotes]

Gucci’s allegations against Frontline satisfied the scienter requirement because:

Laurette completed an application to obtain Frontline’s services, and Nathan Counley, though a Durango employee, is listed as Frontline’s sales agent. Counley “acted as Frontline’s agent in soliciting and directing credit card processing business from replica merchants like the Laurette Counterfeiters” and therefore Frontline may be charged with his knowledge, including his understanding of Laurette’s difficulty to obtain services for selling replicas. Gucci alleges that the “replica acknowledgment” described above that was created for the Laurette website with Counley’s assistance was also reviewed by Frontline, who made suggestions as to where they should place this warning on the website. Even more significantly, Frontline allegedly performed its own investigation of products sold through TheBagAddiction.com as part of Frontline’s chargeback reviews. When faced with a chargeback, Gucci claims that Frontline received supporting documentation from Laurette that included information about the specific item ordered, including a description of the item purchased. Not only did Frontline allegedly review the specific item description, Plaintiff also claims that the relatively small price tag for the item, as well as specific complaints from customers who made chargebacks about not receiving what the website purported to sell, e.g. a product made of genuine leather, should have alerted Frontline that these were infringing products. These fact-specific claims are enough to at least infer that Frontline knew or consciously avoided knowing that the counterfeit products were sold on TheBagAddiction.com

There are a number of analytical problems with this reasoning, but I’m still stuck on the argument that the payment processor is charged with the knowledge of a third party entity’s salesperson. What?

Gucci’s allegations against Woodforest satisfied the scienter requirement because:

As was the case with Frontline, Counley represented himself on Laurette’s application as Woodforest’s sales agent. The application itself said that Laurette was a “wholesale/retail designer [of] handbags,” and listed the supplier as a Chinese bag manufacturer rather than Gucci. Gucci also claims that Woodforest specifically reviewed the website and the products listed on it as part of its initial decision to do business with Laurette. A Woodforest employee allegedly completed an “Internet Merchant Review Checklist,” which required him or her to review the website and confirm whether it contained a complete description of the goods offered. Based on these claims and the website images provided by Plaintiff, even a cursory review of the TheBagAddiction.com would indicate that they claimed to sell replica Gucci products. Indeed, Plaintiff alleges that Woodforest printed out a number of pages that displayed goods that were for sale, including counterfeit Gucci products, and maintained these pages as part of their business records. Woodforest would also perform a second-level review, performed repeatedly after it accepted the business, where an employee would complete a purchase and request a refund. Finally, like Frontline, Woodforest investigated chargeback disputes and received supporting documentation that allegedly should have tipped them off to the infringing conduct. These claims are more than sufficient to suggest, at this stage of the litigation, that Woodforest knew or shielded themselves from the knowledge that Laurette was selling counterfeit Gucci products with their credit card processing system.

Even with the court’s generous standards for scienter, what about control over the infringing instrumentalities? In Lockheed v. NSI, a domain name registrar lacked that level of control because it simply provided a matching service between domain names and IP addresses. In contrast, in Louis Vuitton v. Akanoc, Akanoc arguably had the requisite control because it hosted the sites. Here, Durango was just a matchmaker between merchants and payment service providers, and on that ground lacked the requisite control. However, Gucci sufficiently alleged the requisite control by the payment service providers:

Gucci’s complaint indicates that Frontline and Woodforest’s credit card processing services are a necessary element for the transaction of counterfeit goods online, and were essential to sales from TheBagAddiction.com. Although other methods of online payment exist, such as online escrow-type services like PayPal, generally speaking “credit cards serve as the primary engine of electronic commerce.” Perfect 10, 494 F.3d at 794. Indeed, Gucci points out that Durango’s website claims that “9 out of 10 people use a credit card for their online orders.” As such, without the credit card processing operation set up by these two defendants, Gucci alleges that TheBagAddiction.com would largely have been unable to sell its counterfeit Gucci products. They further support this claim with an affidavit by one of the website owners, who states that “[a]pproximately 99% of payments from my customers were made using credit cards.” Both Frontline and Woodforest processed transactions for cardholders with major credit card institutions-Visa, MasterCard, and so forth-and, according to Gucci, Laurette sold over $500,000 in counterfeit products “during the time they utilized Defendants’ merchant bankcard services.” By processing these transactions, both companies allegedly earned significant revenue from the transaction fees they charged. Put another way, “[t]hey knowingly provide a financial bridge between buyers and sellers of [counterfeit products], enabling them to consummate infringing transactions, while making a profit on every sale.” Perfect 10, 494 F.3d at 810-11 (Kozinski, J., dissenting). Though both Frontline and Woodforest insist they are middlemen with no ability to prevent a transaction, they do not dispute that they could have simply refused to do business with “replica” internet merchants, just like the flea market purveyor who refuses to provide a booth to a counterfeiter. See Compl. ¶ ¶ 87-89 (Woodforest and Frontline “facilitated the Laurette Counterfeiters ability to quickly and efficiently transact sales for Counterfeit Products through their website by enabling customers to use personal credit cards to pay for purchases on TheBagAddiction.com”). According to one of the website operators, “[i]f I did not receive an approval for a credit card charge, I would not ship the customer’s order.” These allegations indicate that the infringing products “are delivered to the buyer only after defendants approve the transaction … This is not just an economic incentive for infringement; it’s an essential step in the infringement process.” Perfect 10, 494 F.3d at 811-12 (Kozinski, J., dissenting).

While all of this is true, how does this relate to the *instrumentality* used to infringe? The court closes the loop by effectively reading that requirement out of the test, saying “instrumentality in this case is the combination of the website and the credit card network, since both are allegedly necessary elements for the infringing act-the sale and distribution of the counterfeit good.” But using this standard, every “sine qua non” vendor to a counterfeit website is an instrumentality–the power company, the water company, the landlord, etc. That’s exactly what the 9th Circuit rejected in Perfect 10 v. Visa. The court weakly distinguishes that case by noting the difference between rivalrous and non-rivalrous goods; the copyright infringing websites could continue publishing the non-rivalrous goods without credit card payment, while the Gucci counterfeit site wouldn’t ship the rivalrous goods until credit card payment was made.

This is a terrible ruling on both a doctrinal and normative level. On a doctrinal level, the court bypassed the main holdings of Tiffany v. eBay (binding on the court), Perfect 10 v. ccBill and Perfect 10 v. Visa. Instead, the court stitched together crappy dicta from the Tiffany v. eBay case with Kozinski’s dissent in Perfect 10 v. Visa to come up with an expansive secondary trademark liability rule applicable to vendors to counterfeit websites. I expect payment service providers to become the latest defendant-du-jour among trademark plaintiffs looking for deep pockets in web infringement cases. Something to look forward to.

Normatively, this ruling raises the specter that payment service providers will attempt to exercise even more business control over the businesses they service, effectively deputizing the payment service providers into cops on the Internet beat. As I mention in my notes about the OECD efforts on Internet intermediaries (which I will post soon), this deputization of private vendors into content cops has numerous disadvantages. I’m hoping this ruling gets fixed by the judge or on appeal so that we don’t suffer the logical consequences of this bad ruling.

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