United States: Small Potatoes: Resolving Conflicting Trademark Laws in the United States

A version of this article was published in Trademark World, October 2004, Copyright © Finnegan, Henderson, Farabow, Garrett & Dunner, LLP

On April 26,2004, the U.S. Supreme Court denied certiorari to hear the appeal of the decision in Idaho Potato Commission v. M&M Produce Farm & Sales, 335 F.3d 130 (2d Cir. 2003), allowing the Second Circuit’s decision in the case to stand.

A landmark in the case law governing certification marks, the Second Circuit’s decision, addresses a major conflict between two well-established principles of trademark law in the United States: the doctrine of licensee estoppel and the special statutory prohibitions designed to protect the integrity of certification marks.

By limiting or possibly eliminating the application of licensee estoppel in the context of certification marks, the Second Circuit mashed the Idaho Potato Commission’s ("IPC") attempt to strengthen rights of certification mark owners and dished up a significant victory for certification mark licensees.

This article explores the issues presented by the cases, comments on the Second Circuit’s decision, and discusses the Idaho Potato Commission’s recent efforts to have this decision legislatively and judicially overruled.

A certification mark, unlike a trademark, does not identify the manufacturer of a product. Rather, it informs consumers that the product bearing the mark meets standards (usually relating to quality or geographic origin) set by the certifying organization that owns the mark. Thus, owned by one entity, the certification mark is used by others. To preserve the integrity of certification marks, Section 14 of the Lanham Act (15 U.S.C. § 1064(5)), requires owners of certification marks to abide by a number of very strict rules. Failure to do so may result in the loss of the certifying body’s rights to the mark.

First, under the rules, certification mark owners may not produce or sell any products bearing the mark. For this prohibition preserves the objectivity of the standards and criteria embodied in the mark. If a certification mark owner is allowed both to set the standards and to sell goods under the same standards the mark owner itself has set, the integrity of those standards would be compromised.

Second, at all times, the owner must exercise control over the use of its certification marks. Control is effected by means of written license agreements with the certified parties. These agreements allow the owner to enforce the certification standards, denying licenses to entities that fall short of the standards and withdrawing licenses from entities no longer meeting the standards. Failure to control use of the certification mark undermines the trust consumers would place in the mark.

Third, the owner must not permit the use of the certification mark for purposes other than to certify. Allowing the mark to convey any message other than the independent verification of the certifier’s standards would detract from the mark’s significance and indeed may cause the mark to lose all meaning in the minds of consumers.

Fourth, the owner may not refuse to certify the goods of any person who meets the standards or criteria the owner has established. This anti-discrimination rule prevents the owner from using non-objective or secret criteria in its certification program or otherwise unfairly favor certain producers over others.

The above rules aim to preserve the integrity of certification marks and foster a free market among producers and distributors of certified products. Any or all of the above grounds may be used by a defendant in an infringement action to invalidate the owner’s mark.

The IPC was created by Idaho statute to promote the sale of Idaho potatoes. In addition to advertising the benefits of Idaho potatoes, the IPC certifies potatoes actually grown in Idaho with a number of certification marks (collectively "the IPC marks").

Potatoes grown in other states cannot bear the certification marks and cannot be marketed as "Idaho" potatoes. The IPC’s elaborate licensing system requires everyone in the chain of distribution, from in-state growers to out-of-state repackers and resellers, to be licensed in order to use the IPC certification marks on their packaging.

The IPC’s standard licensing agreement provides licensees with the right to use the IPC marks in return for the licensees’ promise to use the marks only on potatoes certified as grown in Idaho and meeting the IPC’s other quality standards. The agreement also requires licensees to maintain certain purchase and sales records so that the IPC can periodically monitor its licensees for compliance with the IPC’s standards.

When one of its licensees, M&M Produce Farm & Sales ("M&M"), failed to produce sufficient business records at the IPC’s request, the IPC terminated M&M’s license. The IPC then brought suit against M&M when it discovered that M&M was continuing to repack Idaho potatoes in bags with the IPC marks despite the termination of its license. In response to this suit, M&M counterclaimed for cancellation of the IPC marks on various grounds, including that the IPC discriminated against qualified licensees, refusing to certify potatoes that were actually grown in Idaho, and that the IPC used its certification marks for purposes other than to certify. One of the central issues in the case was whether M&M’s counterclaim could go forward despite a provision in its licensing agreement specifically prohibiting M&M from ever challenging the validity of the IPC marks.

In ruling against M&M on its counterclaim, the District Court held that M&M was estopped from challenging the validity of the IPC marks due to a provision in the licensing agreement in which M&M (1) specifically acknowledged that the IPC marks "are valid, registered marks" and (2) agreed that it would "not during the term of the agreement, or at any time thereafter, attack the [IPC’s] rights" in any of the marks.

Citing a number of trademark cases, the district court held that "courts have consistently enforced estoppel in circumstances directly analogous to this case." It further rejected any arguable distinction between trademarks and certification marks, explaining that "the owners of certification marks can license their marks, just as trademark holders can, and are therefore clearly entitled to licensee estoppel where the licensing agreement specifically provides for it."

According to the general rule of licensee estoppel, when a licensee enters into an agreement to use the intellectual property of a licensor, the licensee effectively recognizes the validity of that property and is estopped from contesting its validity in future disputes. The doctrine of licensee estoppel originally arose out of contract law when courts honored "no-challenge" provisions inserted by licensors in their licensing agreements. These provisions served to protect a licensor’s expectations in the validity of the mark and prevent unfair surprise in litigation.

Over time, however, the doctrine seems to have gradually become grounded more in equity than in contract, with courts applying the doctrine even in the absence of a contractual "no-challenge" provision based upon the equitable principle that a licensee should not be able to challenge the validity of its licensor’s marks because a licensee effectively agrees that the marks are valid by entering into the licensing agreement. In other words, a licensee who has benefited from the rights granted to him by his licensor should not, as a matter of equity, later be able to deny that the licensor had the right to grant those rights in the first place.

Although the courts have consistently applied the doctrine of licensee estoppel in trademark cases,¹ the Supreme Court essentially eliminated the doctrine’s applicability to patent cases with its decision in Lear v. Adkins, 395 U.S. 653 (1969). In Lear, the Supreme Court held that allowing licensees to challenge the validity of their licensors’ patents actually furthers the "strong federal policy favoring the full and free use of ideas in the public domain." In balancing this strong federal policy against the competing demands of licensee estoppel, the Court wrote:

Id. at 670-71.

Thus, the Supreme Court determined that the equitable interest in preventing validity challenges by a licensee is outweighed in the patent context by the strong public interest in allowing such challenges to ensure that non-patentable ideas remain in the public domain. In contrast, post-Lear courts found no comparable public interest in the context of trademark cases to justify disturbing the well-settled doctrine of licensee estoppel.²

THE SECOND CIRCUIT’S DECISION
On appeal, the Second Circuit had to decide whether a certification mark licensee can challenge the validity of its licensor’s certification marks despite a provision in the licensing agreement specifically prohibiting a challenge during or after the term of the licensing agreement.

Noting the relative novelty of the issue, the Second Circuit at the outset observed that "[t]his question has apparently not yet been squarely decided by any federal circuit court."

In resolving the issue, the Second Circuit was faced with deciding whether to apply the doctrine of licensee estoppel and have certification marks follow the route of trademarks, or whether there was some public-policy interest inherent in certification marks that would justify discarding the licensee estoppel doctrine just as the Supreme Court had done in Lear in the context of patent cases.

Though the district court had concluded that the line of trademark cases applying licensee estoppel should be controlling for certification marks because "certification marks are generally treated the same as trademarks," the Second Circuit disagreed. Recognizing that trademarks and certification marks are "generally treated the same," the Second Circuit nevertheless held that differences in the public-policy interests between certification marks and trademarks compelled a different result in the context of certification marks:

Idaho Potato Commission, 335 F.3d at 138 (internal citations omitted).

In other words, although both trademarks and certification marks facilitate consumer expectations in the quality of products, the certification-mark system protects a more substantial public interest: it promotes "free and open competition" amongst the producers and distributors of certified products. Based on simple economic principles, such competition in turn results in the best price and quality for consumers.

As discussed, the legal structure of the certification-mark system is designed to foster such a competitive environment by requiring mark owners to observe strict neutrality in their certification decisions and certify the goods or services of any person who meets the owners’ standards.

In essence, the certification-mark system, with all of the legal restrictions it imposes on certification mark owners, recognizes that a maximum competitive environment ensues when the balance of power between mark owners and licensees is apportioned slightly in favor of licensees. The Second Circuit recognized that not giving licensees the right to challenge the validity of their certifiers’ marks would irrevocably shift this carefully structured balance of power in favor of certifiers: if the validity of a certifier’s marks were held beyond challenge, a certifier would have no real incentive to maintain neutrality and the certification-mark system’s overall goal of maximizing competition among licensees would be jeopardized.

After weighing the competing interests, the Second Circuit thus decided that fostering such competition was a sufficient public interest to justify abandoning the doctrine of licensee estoppel in the certification-mark context, just as the Supreme Court in Lear had decided in the patent context that the public interest in the "full and free use of ideas in the public domain" required patent licensees to be able to challenge the validity of their licensors’ patents. Also, as in Lear, the Second Circuit noted that certification-mark licensees "may often be the only individuals with enough economic incentive to challenge [their certifiers’] licensing scheme, and thus the only individuals with enough incentive to force [certification mark owners] to conform to the law."

The Second Circuit’s opinion prompted a heated response from the IPC, which initially pursued two routes to overturn the -- decision judicially by petitioning the Supreme Court for certiorari, and legislatively by amending the Lanham Act to have certification marks treated the same as trademarks. Although the judicial route came to an end on April 26, 2004, when the Supreme Court denied the IPC’s petition for certiorari, the arguments the IPC raised in its petition, and M&M’s response, are worth considering in some detail.

To convince the Supreme Court to grant certiorari, the IPC cast the Second Circuit’s decision as creating a conflict amongst the circuits on the proper standard to be applied for preempting state contract law. The IPC argued that the Second Circuit failed to apply the proper standard articulated by the Supreme Court in Lear -- whether federal policies would be "significantly frustrated" by state contract law -- and instead conducted an unwarranted and ad hoc balancing of the interests served by state and federal law. Citing to various decisions by circuit courts, the IPC pointed out that the Third, Sixth, and Ninth Circuits had identified the "significant frustration" standard articulated in Lear as the appropriate standard for determining the preemption of state contract law by the federal intellectual property laws.

In arguing that the Second Circuit’s decision would have differed had it applied the correct legal standard, the IPC essentially implied that the public policy behind the Lanham Act is not as great as that embodied in the patent laws to justify preempting state contract law.

"The Lanham Act, unlike the patent laws," the IPC asserted, "does not convey a durable monopoly over ideas, but simply protects the use of certain symbols in commerce to convey information about goods and services to the public." The IPC also argued that there are no fundamental differences between the public policies served by trademarks and certification marks.

In response, M&M argued that the Second Circuit’s decision did not conflict with Supreme Court precedent or with the precedent of other circuits because the Second Circuit based its decision solely on general principles of contract law. General principles of contract law recognized that the IPC license agreement was a "contract of adhesion" and that the no-challenge provision in it was "unconscionable." M&M also argued that certiorari was not appropriate because the case presented competing policy interests, which "are best addressed by Congress."

The legislative route to overturning (or at least modifying) the Second Circuit’s decision still remains a possibility, however. As of this writing, no amendment has actually been introduced in Congress. The IPC’s proposed amendment would add the following sentence to the definition of "mark" in Section 45 of the Lanham Act:

Although the IPC circulated a memorandum summarizing its legislative proposals to various organizations such as the International Trademark Association and the American Intellectual Property Law Association in an effort to rally support for the reversal of the Second Circuit’s decision, neither the INTA nor the AIPLA appears to have taken an official position on this issue.

The broad language of the IPC’s proposed amendment endowing certification marks with the "same rights and protection" as other types of marks is extremely vague. Exactly what are these "new" rights to which certification marks will be entitled?³ Moreover, neither the proposed amendment nor the proposed legislative history specifies whether the amendment is grounded in contract principles (to preclude validity challenges only when there is a specific contractual provision in force), or in equitable principles (to preclude validity challenges even in the absence of specific contractual provisions). Finally, in the authors’ opinions, any such amendment belongs more properly in Section 14 of the Lanham Act (15 U.S.C. § 1064), which deals with the cancellation of registered marks, not in Section 45.

Most importantly, because the IPC’s proposed amendment in effect would completely foreclose validity challenges by licensees, it fails to address the basic concerns raised by the Second Circuit that such challenges are necessary to maintain the integrity of the overall certification scheme. To gain broader support, the amendment must provide for some mechanism by which licensees can redress the failure of certification mark owners to abide by the rules in 15 U.S.C. § 1064(5). Otherwise the legislation will almost surely be viewed as the product of special interests that merely favors the interests of certification-mark owners at the expense of licensees.

Neither the Second Circuit’s decision nor the IPC’s proposed response is completely satisfactory. While the Second Circuit was correct to place a high premium on protecting the integrity of certification marks, a total elimination of licensee estoppel for certification marks may have gone too far. At the same time, the IPC’s proposed legislative changes would probably not accomplish the IPC’s goals and could undermine the integrity of certification marks.

The Second Circuit’s rationale for not applying the doctrine of licensee estoppel in the context of certification marks was that taking away the power of licensees to challenge the validity of their certifiers’ marks would essentially make those marks incontestable and eliminate the certifiers’ incentive to maintain neutrality in their certification schemes. Such a loss in neutrality, the Second Circuit concluded, would hinder competition among licensees and ultimately injure consumers.

According to the IPC, the Second Circuit’s elimination of licensee estoppel effectively denies certification-mark owners any certainty about the validity of their mark. As a consequence, certification-mark owners will now face frivolous invalidity counterclaims from disgruntled licensees every time they initiate enforcement actions. The argument continues that higher litigation costs will increase royalties, which in turn will reduce the number of licensees willing to participate in the certification-mark scheme, and consequently reduce the overall number of choices available to consumers.⁴ Thus, instead of furthering its goal of maximizing competition, the Second Circuit’s elimination of licensee estoppel would actually have the opposite effect and diminish competition.

For the most part, the IPC’s concerns do not appear to have sufficient justification for precluding vitally important validity challenges by licensees--the only mechanisms available to ensure that certifying bodies abide by all the restrictions in 15 U.S.C. § 1064(5). Although the elimination of licensee estoppel may slightly increase the frequency of licensee validity challenges, the cost of having to defend frivolous validity challenges is minimized by the certification-mark owner’s ability to bring a motion to dismiss at the outset of the litigation.

Further, even if the additional validity challenges increase a certification-mark owner’s litigation costs and result in higher royalty rates, this will not necessarily reduce the number of licensees. Because the economic incentive to get certified is directly related to the strength and selling power of the certifier’s standards, obtaining certification should still be economically beneficial for licensees so long as the certifier has been successful in promoting standards and the public believes that those standards are important.

In other words, if licensees find that it is not profitable for them to continue certification due to a slight increase in royalties, the fact that they discontinue certification means only that the selling power of the certifier’s standards is not great enough to justify the increased costs. In such a situation, the market should essentially correct itself by forcing mark owners to make their standards more stringent or market their standards more effectively until licensees find that getting certified is economically beneficial.

Nevertheless, the Second Circuit may have gone too far if its decision eliminates all licensee estoppel for certification marks. In addition to the restrictions set forth in 15 U.S.C. § 1064(5), the validity of certification marks can be challenged on the very same grounds as ordinary trademarks, including genericness, descriptiveness, abandonment, and prior rights. Preserving a licensee’s right to challenge certification marks on such traditional trademark grounds would not further the goal of maintaining objectivity in the application of certification programs. Rather, it will simply increase litigation costs as the IPC predicts without any offsetting positive effect on competition.

Indeed, when the validity challenge is based on traditional trademark grounds rather than the specific certification-mark restrictions, the rationale justifying licensee estoppel applies equally well to both trademarks and certification marks, namely the licensee has conceded the validity of the mark by entering into the licensing agreement. As with a trademark, no licensee should be able to reap the rewards of using a certification mark and then when the license is terminated claim that the certification mark is generic. If the mark was inherently generic, the licensee should have recognized it immediately and never have entered into the license.

In contrast, a certification-mark licensee would not necessarily be able to tell immediately whether the certifying body was abiding by the restrictive provisions of 15 U.S.C. § 1064(5) until it has entered into the license agreement. Accordingly, preserving the doctrine of licensee estoppel with regard to traditional trademark-validity challenges is justified for certification marks and trademarks alike.

As the Second Circuit opinion does not address this particular point, perhaps subsequent decisions will clarify the situation and limit the Idaho Potato Commission holding to allow licensee challenges only for the grounds enumerated in 15 U.S.C. § 1064(5).