Why Online Marketplaces Don’t Do More to Combat the SAD Scheme–Squishmallows v. Alibaba

This appears to be a SAD Scheme case involving Squishmallows, a stuffed animals brand. The brand owner, Kelly Toys, sued 90 e-commerce merchants in a sealed complaint and got a TRO.

For unclear reasons, Kelly Toys expanded the litigation to add online marketplaces Alibaba and AliExpress as defendants. This is an unusual move. Normally, SAD Scheme rightsowners don’t sue online marketplaces because that brings in well-funded and highly motivated defendants who will jack up the litigation costs substantially. Instead, the rightsowners usually view online marketplaces as their ATMs–the marketplaces possess the merchants’ funds, and the rightsowners aspire to transfer those funds into their bank accounts. Online marketplaces will make judgment calls that help rightsowners get that cash–but only when they aren’t treated as adversaries. This dynamic leads to a détente: rightsowners don’t sue online marketplaces, and online marketplaces play ball with rightsowners. This détente comes at the expense of online merchants and consumers.

Having broken that détente, the Alibaba defendants predictably fought back. In an inappropriately brief 4-page ruling, the court denies the Alibaba defendants’ motion to dismiss. The court credits the following claims by Kelly Toys:

• “the Alibaba Defendants were “made specifically aware of many defendants,” including “several Merchant Defendants named in this action, and their specific infringing and counterfeiting activities,” through orders in six separate lawsuits against sellers on Alibaba and AliExpress.”
• “infringing listings — including some by the Merchant Defendants — have continued to proliferate on the Alibaba platforms. These include postings that the Alibaba Defendants had been advised were in violation of the “three-strike policy” they use to terminate the accounts of repeat offenders”
• “Alibaba Defendants affirmatively promoted or assisted in promoting infringing listings in several ways, including by granting infringing Merchant Defendants “Gold Supplier” and “Verified” status, selling keywords related to Squishmallows to Merchant Defendants and other purported counterfeiters, purchasing keywords on Google to promote infringing listings, and generating promotional emails advertising infringing listings”
• “the Alibaba Defendants reap financial benefits from this conduct, by attracting customers, leading merchants to pay for additional services, and earning commissions on transactions”

There’s so much to unpack here, and the court does none of it. As just one example, the keyword ads issue was squarely addressed in the Second Circuit’s Tiffany v. eBay opinion–remarkably uncited here.

The court does briefly acknowledge the Second Circuit’s Business Casual v. YouTube ruling, but only to say it doesn’t help. This court distinguishes the Business Casual case by saying there were no allegations that YouTube had knowledge of the infringement, which is an imprecise summary. The Business Casual court actually said YouTube didn’t have knowledge before receiving takedown notices. Here, it looks like Kelly Toys alleged recidivism, but the complaint should be limited to those circumstances–any other allegations should have been dismissed. This court also rejects any 512 defense, saying it’s an affirmative defense and its application isn’t clear from the complaint’s allegations.

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Obviously, this is just a motion to dismiss. The Alibaba defendants can mount vigorous defenses against the lawsuit at summary judgment. Still, it’s illustrative of a broader point about SAD Scheme cases worth reinforcing.

I’ve said that SAD Scheme TROs are like “super-notices” compared to DMCA takedown notices. A DMCA notice should only work on an item-by-item basis, so a merchant might get multiple notices before an online marketplace cuts them off. A SAD Scheme TRO tells the online marketplace that a court has adjudicated the merchant as an infringer (not really, because it’s an ex parte TRO, but judges still accept that fiction), which dramatically increases the risk that a future court will treat that online merchant as a recidivist if the online marketplace doesn’t cut it off. Thus, online marketplaces feel compelled to shut down the online merchant based on the TRO to avoid future liability, even if they are not legally obligated to honor the TRO per FRCP 65 and even if an equivalent takedown notice regarding the merchants’ items would have removed only the targeted items.

This is why I think the old notice-and-takedown scheme is coming to an end. The SAD Scheme gives rightsowners the staydown rights they have always wanted. Until the SAD Scheme is stopped, rightsowners will categorically prefer it over the less effective takedown notices.

This ruling emphasizes the risks when a court thinks an online marketplace caters to recidivist merchants. Definitely no motion to dismiss; and now the rightsowner gets the chance to hunt in discovery for smoking guns.

This ruling brought to mind the Car-Freshner v. Facebook ruling from last month. In that case, Facebook didn’t robotically honor trademark takedown notices when they seemingly overreached to target parodies and more. For its principled stand, Facebook also lost a motion to dismiss. Collectively, rulings like this send a message to online marketplaces: don’t get cute with takedown demands or TROs; just immediately honor them regardless of legitimacy.

Case Citation: Kelly Toys Holdings, LLC v. 19885566 STORE, 2023 WL 8936307 (S.D.N.Y. Dec. 27, 2023).