Exhaustion of rights and liability for joint tort – the hazards of e-commerce platforms

Friday 29 April 2022

Winnie Tam SC
Barrister, Des Voeux Chambers, Hong Kong

Stephanie Wong
Barrister, Des Voeux Chambers, Hong Kong

With the pandemic hitting hard, online shopping has become the new normal. The pandemic accelerated the shift towards a more digital world and fuelled e-commerce growth as consumers flocked to online platforms to shop for daily essentials and other goods, not just on a business-to-consumer basis but on a consumer-to-consumer basis as goods and services become more ‘fluid’ and transactions become less territorial.

In the recent case of Mary Kay Inc and Others v Zhejiang Tmall Network Co Ltd and Others [2021] HKCFI 1403, [2022] HKCA 360, the Hong Kong Court of First Instance (CFI) and Court of Appeal (CA) gave insightful guidance on the boundaries of joint liability of e-commerce platforms and exhaustion of rights, in a case involving alleged ‘unauthorised’ sale of otherwise genuine goods on the giant online platforms, Taobao and Tmtall. The case is a timely reminder on the territorial nature of intellectual property rights. The claims brought by the plaintiff in the case were succinctly summarised by the CFI as a:

futile attempt to create jurisdiction for the Hong Kong court for a complaint not recognised under Hong Kong law under the guise of intellectual property infringement, i.e. a right to control the channels through which third-party sellers re-sell to customers in the Mainland genuine goods sourced from the brand owner.’

The judgments were given on the application of the first to third defendants, who are operators of the e-commerce platforms generally known as ‘Taobao’ and ‘Tmall’, to set aside the service out order on them and to oppose the plaintiffs’ default judgment application, and its subsequent unsuccessful appeal to the Court of Appeal by the plaintiffs.

The plaintiffs are part of the United States direct sale conglomerate that market skin care and cosmetics products under the trademark of ‘Mary Kay’ (‘玫琳凱’) through the ‘direct-selling’ business model, that is, the plaintiffs authorise direct sales representatives (DSRs) to market their products to individuals, who are persuaded to enrol as DSRs themselves, thereby expanding the network of sales agents for Mary Kay. DSRs enjoy discounts on recommended retail pricing commensurate with the quantity they purchase and are contractually bound to dispose of the goods only through direct selling. While the contract terms between Mary Kay and DSRs do not expressly prohibit sale through online shopping platforms, Mary Kay maintained that sales other than in-person direct sale was prohibited. The plaintiffs placed several trap orders to secure evidence of their products being sold by the fourth and fifth defendants on Tmall. but only after they were approached by the platform operators to check the veracity of their authorisation. No evidence of sale to Hong Kong was obtained against Taobao.

The evidence shows that Tmall prides itself as a 'B-to-C' platform that requires traders to prove that they are authorised by the relevant trademark owner to sell the trademarked goods they sell as an on-boarding requirement. Both platform operators have built fast-acting notice-to-take-down mechanisms to combat counterfeits upon complaint.

At the stage of the ex parte application for service out of jurisdiction on the first and second defendants, the plaintiffs presented the case as an ordinary infringement action targeting internet traders and the hosts of the trading platforms selling to Hong Kong, without pointing out the following two crucial facts:

  1. the products complained of are genuine products originating from the plaintiffs, raising acute issues on the defence of ‘exhaustion of rights’ under section 20 of the Trade Marks Ordinance (TMO); and that
  2. the first to third defendants never sold any goods on Taobao and Tmall but are merely neutral secondary online marketplace operators, hence raising issues on the boundaries of joint liability of such e-commerce platform operators; and
  3. Taobao declined to export the goods to Hong Kong.

The first and second defendants applied to set aside the service out order on the following grounds:

  • there is no serious issue to be tried in respect of the plaintiffs’ claims against the first and second defendants;
  • the plaintiffs have failed to show a good arguable case that any of their claims against the first and second defendants fall within the statutory gateways for service out of jurisdiction;
  • Hong Kong is not an appropriate forum;
  • there were serious material non-disclosures and misstatements in the service out application.

When faced with the application to set aside service out, the plaintiffs postulated that Tmall, by accepting the documents tendered as part of the on-boarding requirements, had held the traders out as being authorised to sell the Mary Kay products, when they were not so authorised under the DSR contracts. The plaintiffs also relied on the fact that some of the samples obtained on trap purchases had been ‘tampered’ with, by their production lot codes having been obliterated by a small scratch through the shrink wrap to prevent tracing of the DSR to whom the products had been distributed. The plaintiffs alleged that the ‘tampering’ would impair the condition of the goods as it would make any recall of the product impossible. The authorisation documents had turned out to have been forged but this was not discovered until after the platform operators approached the plaintiffs for clarification after a disgruntled ex-employee of one of the traders tipped them off.

The CFI’s findings

The court found in favour of the first and second defendants on all these grounds.

The court held that there is no serious issue to be tried on trademark infringement and passing-off allegedly committed in Hong Kong by the two traders, and that in any event the platform owners were not liable as joint tortfeasors.

The fourth and fifth defendant’s primary liability – exhaustion of rights

Since the goods complained of are genuine products, the court held that the defence of ‘exhaustion of rights’ under section 20 of the Trade Marks Ordinance applied, despite the plaintiffs’ contention that the condition of the products have been changed or impaired by the obliteration of production codes on the shrink-wrap packaging as described above.

Section 20 of TMO provides:

  1. […] a registered trademark is not infringed by the use of the trademark in relation to goods which have been put on the market anywhere in the world under that tradmark by the owner or with his consent (whether express or implied or conditional or unconditional).
  2. Subsection 1 does not apply where the condition of the goods has been changed or impaired after they have been put on the market, and the use of the registered trademark in relation to those goods is detrimental to the distinctive character or repute of the trademark.’

Having carefully compared the language of section 20(2) of the TMO (exception to the exhaustion of rights defence) and Article 7(2) of the Trade Mark Directive in the European Union and section 12(2) of the Trade Marks Act 1994 in the United Kingdom, the court held that the Hong Kong provision is narrower in scope, which applies only if the ‘physical condition of the goods’ (as opposed to the ‘mental condition of the goods’) have been changed or impaired. There was no evidence that the obliteration of the code without damaging the packaging as a whole would in any way affect the quality of the goods inside. Following Zino Davidoff SA v A & G Imports Ltd [2000] Ch 127, a case cited to the plaintiffs lawyers in pre-action correspondence, the court held that the ‘mental’ condition of the goods had remained intact.

The court also rejected the plaintiffs’ argument that the products were not ‘put on the market’ by the plaintiffs or with their consent on the basis that the DSRs were prohibited from retailing the products, as that would be ‘confusing the line between contract law and trademark law’.

The court’s conclusion on exhaustion of rights is plainly correct. A further reason in support of the conclusion is that the Hong Kong provision is, in fact, wider in scope than the EU/UK counterparts, reflecting the legislative intent favouring parallel import:

    1. Hong Kong adopts an ‘international exhaustion’ regime (goods having been ‘put on the market anywhere in the world’) whereas the EU and UK adopt the ‘regional exhaustion’ regime;
    2. the Hong Kong provision includes consent (whether express or implied or condition or unconditional), whereas the EU/UK provisions simply refer to ‘consent’;
    3. the exception to the Hong Kong provision is narrower, as observed by the court. The legislative intention is clearly to favour parallel import, and hence the section should be construed liberally.

The sale from the plaintiffs to their contracted DSRs passes to the DSRs the property in the products, who are supposed to recommend the products to others potential DSRs in their capacity as users. That is the very nature of direct selling. The DSRs are themselves the ‘market’. Even taking the plaintiffs’ argument at its highest, sale to the DSRs with certain conditions on resale would still amount to a ‘conditional consent’ expressly recognised by section 20 of the TMO. The economic value of the trademark having been realised by the sale of the goods bearing the mark, the exhaustion of rights defence prevents the proprietor of the trademark from controlling the subsequent exploitation of the trademark by further sale of the goods: Samsonite IP Holdings Sarl v An Sheng Trading Pte Ltd [2017] SGHC 18.

On passing-off, the court held that since the goods in question are genuine products, there is no deception (let alone misrepresentation made in Hong Kong) under the classical trinity requirements. In fact, the evidence is that on the Tmall platform, the two traders specifically pointed out the codes on the products may have been removed, because they are sold at a price below the recommended price for direct sale. The fact that the goods were not ‘authorised’ in its manner of sale was not made a hidden fact but was advertised to attract consumers.

The court therefore concluded that the liability is not established even as an arguable case against the primary tortfeasors. It follows that the first and second defendants are not liable as joint tortfeasors.

Joint liability of the first and second defendants as online platform operators

The court, in obiter, went on to apply L’Oreal SA v eBay International AG [2009] RPC 21 and held that the first and second defendants were not liable as joint tortfeasors as there was no evidence of authorisation or procurement, nor any evidence of common design. In particular, the court observed that the first and second defendants were under no legal duty to prevent infringement, but instead provide a ‘Notice-To-Take-Down’ procedure in place to combat counterfeiting, which the plaintiffs did not take advantage of despite their knowledge of the ‘unauthorised’ trading under complaint.

Material non-disclosure

The CFI also identified six aspects of material non-disclosure by the plaintiffs in their ex parte application for service out, including, inter alia, that the failure to inform the court that the products complained of in fact originated from the plaintiffs, the defendants’ reliance on the defence of exhaustion of rights, and the defence available to neutral online platform operators.

The CA’s findings

The plaintiffs applied for leave to appeal against the CFI’s decision, which was refused by the CA.

Instead of attempting to determine whether the decision on ‘no serious issues to be tried’ on trademark infringement and passing-off should be upheld, the CA confined its decision to the grounds of appeal in relation to material non-disclosure, default judgment and submission to jurisdiction. These grounds alone would have determined the success or failure of the appeal.

On appeal, the plaintiffs asserted that the judge below has overlooked their argument on the goods not having been ‘put on the market by the plaintiffs’ in accepting the exhaustion of rights defence, relying heavily on the Singapore decision of Samsonite (see above). The authority was cited to the judge only at the hearing, and not referred to in his decision. The CA, prudently, did not rule on how the authority may or may not be applied, stating that it would require a detailed examination of the facts in order to determine the relevant ‘market’, but resolved it under the head of material non-disclosure: the plaintiffs ought to have made full and frank disclosure on whether the goods did originate from them, and the potential defence of exhaustion of rights extensively debated in solicitors’ correspondence. The ex parte order on service out was liable to be set aside.

The Samsonite case

The Samsonite case does raise interesting issues as to the proper interpretation of the relevant ‘market’ under section 20 of the TMO. The Singapore Court took the view that the expression ‘put on the market’ refers to the situation where:

‘an independent third party has acquired the right of disposal of the goods bearing the trade mark. The acquisition by an independent third party of the right of disposal must be an act that simultaneously allows the proprietor of the trade mark to realise the commercial or economic value of the trade-marked goods, and deprives him of the right to control the subsequent exploitation of the goods [… ] Additionally, the precise “market” in question is contingent on the precise factual matrix of each case and the economic objective of the particular trade mark proprietor’ [100].

That said, Samsonite is a case decided on its own particular facts. Pursuant to the terms of a co-branding agreement between Samsonite and Lenovo, Lenovo would give away for free the co-branded backpacks manufactured by Samsonite in conjunction with the sale of certain models of Lenovo laptops in China, and Lenovo and its retailers were prohibited from selling or otherwise disposing of the co-branded backpacks independently from the sale of a laptop computer. However, in breach of the distribution agreement, some of Lenovo’s authorised dealers sold the unbundled pack backs without Lenovo laptops to unauthorised dealers who subsequently sold the unbundled backpacks to the defendant, who imported them into Singapore.

Applying the test to the facts, the Court took into account the objective of Samsonite to penetrate the Chinese consumer market and to create awareness of its brand. The relevant ‘market’ was accordingly held to be the retail (end-user) market in China, and that the commercial value of the Samsonite marks would only be realised if a purchaser of a Lenovo laptop has received a Samsonite backpack as a free gift along with a laptop computer he purchases. Without the backpacks reaching Chinese consumers in the retail market in China, the purpose of the marketing exercise could not have been served. Therefore, there was no realisation of the economic value of Samsonite’s trademark on the backpack. Samsonite received no profits either. The Court rightly held that the backpacks have never been ‘put on the market’ in light of Samsonite’s economic objective.

The facts of Mary Kay v Tmall stand in stark contrast to Samsonite. As defence counsel contended, the plaintiffs’ commercial purpose is to sell as many of their branded products as possible, starting with selling them to the DSRs, who have to fully pay for the goods with limited rights of return. There was no obligation to resell, only incentives in terms of pricing. The DRSs are as much the retail market to the plaintiffs as the consumers to whom the DSRs sell and in turn recruit as DSRs. The economic value of the plaintiffs’ trademark have therefore been realised with the outright sale of the products to the DSRs. In parallel, the plaintiffs continue to enjoy contractual rights to regulate the nature and conduct of onward sales activities, as a means of widening the plaintiffs’ distribution channel. It was remarked in Samsonite, as obiter dicta, that realisation of economic value only by an act of sale is too narrow, as it can be achieved through multifarious methods, not just through an actual sale of the trademarked product. However, with the outright sale by the plaintiffs to DSRs and the simultaneous extraction of profits, the argument that no economic value is realised unless and until onward sales comply with contractual requirements is at best circular. The related point of ‘conditional consent’ is separately discussed above.

Where trademark rights end in sale and distribution of goods

One must not lose sight of the theoretical underpinning of the exhaustion of rights defence. From the general public’s perspective, parallel import may create consumer welfare as the consumers benefit from lower prices. On the other hand, if the trademark owner has already received a fair reward from the dealings with the products once, he must be deemed to have foregone his control over the right of disposal of the product. The purchaser of the goods must be free to dispose of them without offending trademark law. From the trademark owner’s perspective, if he wishes to exercise any control over the channel of further sales after the trademark has been exploited once, he must rely on contract.

The failure to disclose the platform operators’ reliance on the exhaustion of rights defence and on L’Oreal v eBay was rightly held to be material in this case. Without having to decide on the applicability of L’Oreal v eBay, the CA sees the force in the defendants’ counsel’s submission that it defies common sense to say that the more conscientious a platform operator is in protecting intellectual property rights, the easier it will fall victim to allegations of joint tortfeasance from the intellectual property owner when his efforts fail to achieve their intended result.

While the principles in L’Oreal v eBay, Zino Davidoff and Samsonite are yet to be finally applied on tested evidence, the reasoning in the two judgments provides support for platform operators who merely facilitate in the commercial activities of traders in selling goods. Any anti-counterfeiting measures in vetting traders are unlikely to be taken as contributory to any allegation in joint tort. A future decision upon trial on the boundary between contractual rights and trademark rights in support of the doctrine of exhaustion of rights would be welcome.