By Jerry Meek

Claims for trademark or service mark infringement are usually brought pursuant to the Lanham Act, 15 U.S.C. § 1051 et. seq.  But that Act contains no statute of limitations.  So when infringement occurs, how long do you have to seek redress?

Some Courts – including the Fourth Circuit – draw on the statute of limitations of analogous state laws to determine the applicable statute of limitations.  See PBM Products, LLC v. Mead Johnson & Co., 639 F.3d 111 (4th Cir. 2011).   As a result, claims based upon infringing activity that occurred outside of the State’s analogous statute of limitations will be barred.  This means that, for statute of limitations purposes, the time limit will often vary based upon state law.

But, as illustrated in a recent First Circuit decision, other Courts determine the applicable time limit by applying the equitable doctrine of laches, either in lieu of the State’s analogous statute of limitations or to supplement that statute of limitations.  In Oriental Financial Group, Inc. v. Cooperativa de Ahorro y Crédito Oriental, 11-1473, 11-1476 (1st Cir. Oct. 18, 2012), the plaintiff and defendant were competing financial institutions, providing services in Puerto Rico.  The plaintiff began using the mark “ORIENTAL” in connection with its services in 1964.  The defendant first began using the term “oriental” as part of its corporate name in 1966 and adopted the mark “COOP ORIENTAL” (or some variation thereof) in 1995.

In 2009, the plaintiff sent a cease and desist letter to the defendant, demanding that it cease the use of the ORIENTAL mark.  When litigation ensued, the defendant argued – in part – that the injunction sought by the plaintiff against the defendant’s use of the ORIENTAL mark was barred by the doctrine of laches.

As the Court noted, “[l]aches . . . is an equitable doctrine which penalizes a litigant for negligent or willful failure to assert his rights. . . .”  Id.  It requires proof of:  “(1) lack of diligence by the party against whom the defense is asserted, and (2) prejudice to the party asserting the defense.”  Id.  Laches only applies, however, “where the plaintiff knew or should have known of the infringing conduct.”  Id.

The First Circuit held that, regardless of whether these elements of a laches defense can be shown, the defense itself is barred by the doctrine of progressive encroachment.  The “progressive encroachment doctrine requires proof that (1) during the period of the delay the plaintiff could reasonably conclude that it should not bring suit to challenge the allegedly infringing activity; (2) the defendant materially altered its infringing activities; and (3) suit was not unreasonably delayed after the alteration in infringing activity.”

As to the second element, the Court found that between 2008 and 2010 (when the plaintiff filed suit), the defendant “materially altered the reach of both its operations and its allegedly infringing advertising. “  Specifically, the defendant’s activities expanded geographically to encompass more regions in Puerto Rico.  The defendant also expanded its advertising efforts in 2009, reaching far more consumers.  As a result, the defendant grew from a “regional to an island-wide business” more “squarely in competition with the plaintiff.”  As to the third element, the Court noted that the plaintiff filed suit “shortly after these changes occurred.”

Finally, the Court considered the first element – whether the plaintiff could have reasonably concluded that it should not bring suit.  Obviously, the plaintiff could not have been expected to file suit until it had a claim.  The test, therefore, is “whether and when any likelihood of confusion may have ripened into a claim.”  The Court found that any pre-2009 infringement was de minimis and thus “it was reasonable as a matter of law for [the plaintiff] to delay bringing suit.”

The doctrine of laches is premised on the idea that it would be inequitable for a party to simply sleep on its rights.  That is, in the context of trademark or service mark infringement, a senior user should not be allowed to wait, while a junior user spends money and time developing a mark and expanding its business based on that mark, only to later act to prevent the mark’s use.  In addition, since infringement actions are designed to protect consumers by eliminating confusion in the marketplace, allowing infringement to unnecessarily persist undermines free market mechanisms.

But, as the doctrine of progressive encroachment suggests, the policy rationale underlying the doctrine of laches can sometimes be trumped by the need to protect senior users who, through no fault of their own, were caught off-guard by a junior user’s expanded use of the mark.

By Jerry Meek

I’m not a big music fan, but a decision last week by the U.S. District Court for the Southern District of New York caught my eye.

It seems that Ryan Leslie – described in his Wikipedia page as an “American record producer, singer-songwriter, multi-instrumentalist and occasional rapper – lost his laptop and external hard drive while on tour in Germany.  Lost too was apparently some of Leslie’s intellectual property, including music and videos relating to his records and performances.

So Leslie posted a YouTube video, offering a $20,000 reward for the equipment’s return.  Eleven days later, he posted a second video, vowing to continue his “Euro tour” and increasing the reward to $1 million.

After Armin Augstein found and returned the laptop and hard drive, Augstein naturally wanted his reward.  When Leslie refused to pay up, Augstein sued.  Leslie argued that the offer for a reward wasn’t really an offer at all – instead, it was an “advertisement” or mere “invitation to negotiate.”  The offer was made on “YouTube,” he added, suggesting that no one could have taken it seriously.  Besides, he argued, he tried to access the intellectual property after the equipment was returned and couldn’t.  The reward had been offered, he contended, not for the equipment itself, but for the intellectual property the equipment held.

But, as the Court noted in Augstein v. Leslie, 11 Civ. 7512 (S.D.N.Y. Oct. 17, 2012), there was no dispute that – even after receiving notice of a potential lawsuit against him – Leslie allowed the equipment’s manufacturer to delete everything and send Leslie a replacement.  So, we’ll never know what was on the equipment.

According to the Court, the key question in resolving whether this was an “offer” or a mere “advertisement” is whether a “reasonable person” would have believed that this was an offer.  Here, Leslie’s offer was for someone to perform a specific action – finding the property.  As a result “a reasonable person viewing the video would understand that Leslie was seeking the return of his property and that by returning it, the bargain would be concluded.”

In addition, given that litigation was all but certain at the time that Leslie authorized the manufacturer to destroy the equipment, “Leslie and his team were at least negligent in their handling of the hard drive.”  The Court therefore sanctioned Leslie with an adverse inference – in other words, the Court ordered that it will be “assumed that the desired intellectual property was present on the hard drive” when Augstein returned it.

Augstein doesn’t have his reward yet.  But it looks like he’s well on his way.

By Jerry Meek

If you run a business, there are a few things you should know about politics and taxes.

1. There’s no bad debt deduction for debts owed by political organizations.  Accrual method taxpayers are accustomed to reporting income when earned, regardless of when they actually get paid.  If, in a later tax year, they don’t get paid, they are generally allowed a bad debt deduction.  But, under I.R.C. § 271, if you provide goods or services to a political organization (including a political party or any committee which attempts to influence an election) and the organization doesn’t pay up, a bad debt deduction is disallowed.  There is an exception if more than 30% of your receivables come from such organizations and you make continuing efforts to collect on the debt.  And, obviously, cash method taxpayers need not be concerned, since they report income only when the bill is paid.  The obvious policy rationale behind this rule is to prevent people from converting otherwise non-deductible political contributions into tax deductions.  But the unaware can get hit twice – once when the customer fails to pay up and again when the IRS disallows a deduction on the bad debt.

2. Political expenses are not deductible.  Almost every business owner knows that “ordinary and necessary” business expenses are deductible.  What if your business buys an ad in a political program or a ticket to a political event?  Is this deductible if the expense is incurred to promote your business?  Under a special provision of Internal Revenue Code, it is not.  I.R.C. § 276 disallows a deduction for such “indirect contributions,” including expenses for:  (1) advertising in a publication if part of the proceeds supports a party or candidate; (2) admission to any dinner or program if part of the proceeds support a party or candidate; or (3) admission to a gala, parade, concert, or “similar event” if “identified with” a party or candidate.

3. Most – but not all – lobbying expenses are not deductible.  Let’s say that whether your business thrives or struggles depends on what happens with a particular bill in Congress or the State Legislature.  Can you deduct any expenses incurred in lobbying for or against the bill?   No you can’t.  Under I.R.C. § 162(e), no business deduction is allowed for expenses incurred in connection with influencing legislation, attempting to influence the public on legislative matters, or directly communicating with certain executive branch officials in an attempt to influence official actions.  There are three important exceptions to the rule.  First, the rule doesn’t apply to “local legislation.”  So, for example, if you spend money trying to lobby the City Council on a zoning issue, this is fully deductible (provided it meets the other requirements for a business deduction).  Second, if someone in-house does the lobbying, you can continue to deduct that person’s full salary, provided that the amount attributable to lobbying does not exceed $2000 in any taxable year.  Finally, if you are in the business of lobbying, the rule obviously doesn’t apply.

4. Illegal bribes or kickbacks to government employees are not deductible.  There are a lot of reasons why you shouldn’t pay bribes or kickbacks to government employees.  There are criminal sanctions for doing that, regardless of whether the official or employee is here in United States or in a foreign nation.  But if that’s not a sufficient deterrent, I.R.C. § 162(c) disallows a deduction for any such payments made.  The regulations provide one example:  a company in the business of selling hospital equipment hires a moonlighting employee whose full time job is Superintendent of Hospitals.  If done to procure an improper advantage in violation of state law, the employee’s salary is not deductible.

By Jerry Meek

When a potential dealer submits an application for a dealer franchise, can the dealer be liable for failing to fulfill the commitments made in the application?  Perhaps not, one court recently said in Volvo Trucks North America v. Andy Mohr Truck Center, No. 1:12-cv-448 (S.D.Ind. October 9, 2012).

In 2009, Andrew Mohr and his company applied for a Volvo trucks dealer franchise.  In the process, he submitted a Dealer Application to Volvo, in which – according to Volvo – he made “several promises, representations and unqualified guarantees.”  In the application, for example, Mohr indicated that he would:  “promote and lead Volvo to a dominant market share position”; secure certain accounts; move into a new facility; “commit the resources necessary to create a strong dealer image with proactive prospecting”; build a new long-term facility for its operations; and place an initial parts order of $1 million.

His application was approved, resulting in a Dealer Agreement.  But, as the Court noted, “things have since gone south.”  Volvo sued Mohr and his company, alleging – among other things – that he fraudulently induced them to enter into the Dealer Agreement, that he engaged in “constructive fraud” and that he was liable to Volvo under a theory of promissory estoppel.  Mohr sued Volvo back, alleging several claims, including breach of the Dealer Agreement.

The Court threw out Volvo’s claims of fraudulent inducement, constructive fraud, and promissory estoppel.  For there to be fraudulent inducement, the defendant must make a false representation about past or existing facts.  All of the representations made by Mohr, according to the Court, were about what Mohr planned to do in the future.  Thus, there was no basis for Volvo’s fraudulent inducement claim.

Constructive fraud generally requires the existence of a confidential or fiduciary relationship between the parties.  In some very limited circumstances, the relationship between a buyer and seller can give rise to a constructive fraud claim.  But here, the Court ruled, no such relationship existed between the parties.

Finally, a promissory estoppel claim can arise when a defendant makes promises, which the plaintiff reasonably relies upon to the plaintiff’s detriment.  Here again, the Court rejected Volvo’s position.  Like most Dealer Agreements, the Dealer Agreement between Volvo and Mohr contained an “integration clause,” providing that the written agreement superseded any other prior agreements or communications between the parties.  Thus, “as a matter of law,” any promises made by Mohr in the Dealer Application were superseded by the Dealer Agreement.  In addition, said the Court, “any reliance by Volvo on the Defendants’ promises was legally unreasonable (not to mention colloquially unreasonable, given that it is Volvo’s own contract that includes the integration clause).”

Despite these victories, Mohr and his company are not out of the woods yet and this lawsuit may not end soon.  Volvo still has three claims left standing, and Mohr has six counterclaims yet to be resolved.

By Jerry Meek

The limited liability company (or “LCC”) is now available in every state in the United States.  Such entities have become the darlings of incorporators, largely because they offer the advantages of limited liability, combined with the tax advantages of pass-through taxation (unless some other classification is affirmatively elected).  Under the default rules, the LLC’s income and deductions “pass-through” to the owner or owners, eliminating any entity-level tax and thus avoiding the double-taxation characteristic of C-corporations.

But attorneys who advise foreign persons and entities investing in the United States should tread with caution, because not all national governments treat the LLC so favorably.  In fact, many foreign governments wrestle with how to classify such hybrid entities, both under their own national law and under various treaty obligations.

Take, for example, the decision of the United Kingdom’s Upper Tribunal Tax and Chancery Chamber, upholding the position of Her Majesty’s Revenue and Customs (HMRC).  In HMRC v. Anson, [2011] FTC/39/2010 (TCC 2011), George Anson, a resident of the United Kingdom, was a Member of a Delaware LLC.  As is common, the LLC distributed profits to its Members quarterly, withholding U.S. taxes on distributions to its foreign Members.  Anson reported the income on his personal tax return in the United Kingdom and also sought foreign tax credits for the taxes paid to the United States.

Under the relevant tax treaty between the United States and the United Kingdom, any tax paid in the United States could be credited against “any United Kingdom tax computed by reference to the same profits or income by reference to which the United States tax is computed.”  HMRC argued that the tax paid in the United States resulted from income belonging to the LLC.  The tax paid in the United Kingdom, in contrast, was the result of distributions contractually required by the LLC’s operating agreement.  Anson argued, in response, that his right to the profits arose as the profits were generated.  Thus, the tax on the distributions was computed by reference to the same income that gave rise to tax in the United States.

In the court’s estimation, the deciding factor was whether Anson’s right to the profits was proprietary or contractual.  That is, was Anson’s right to receive distributions a right of ownership or a contractual right?  Under Delaware law, the court noted, the profits and losses of an LLC are allocated in accordance with the operating agreement.  Even though the agreement may require distributions in certain intervals based upon the LLC’s profits and allocations, this is not the same as a proprietary or ownership right to the distribution.  Instead, the profits remain as assets of the LLC until distribution.  Since the tax imposed by the United Kingdom is a tax on Anson’s contractual rights, and the tax imposed in the United States is a tax on profits of the LLC, Anson was not being taxed twice on the same income.  Thus, the court concluded, he was not entitled to foreign tax credits.

The end result, of course, is that the advantage of pass-through tax treatment ordinarily available through ownership of an LLC was unavailable to Anson.  Anson ended up suffering many of the tax burdens suffered by C-corporation shareholders.  One tax essentially was paid on income belonging to the LLC; a second tax was paid on the distributions received by Anson.

It is perhaps not all that surprising that foreign governments struggle with the proper tax classification of the U.S. LLC.  After all, it was largely the emergence of the LLC which prompted the Treasury to adopt the “check-the-box regulations” in 1996, putting an end to the decades of facts-and-circumstances analyses used to determine whether an entity should be classified as a corporation or a partnership for tax purposes.  Foreign investors owning interests in U.S. LLCs don’t have it so lucky.

By Jerry Meek

When a C-corporation sells an asset and the corporation’s owner goes to work for the buyer, there may be an incentive for the parties to pay the owner a higher salary than the market will bear, as disguised payments for the asset.  That’s because the purchaser can currently deduct salary, but must capitalize any purchase payments.  At the same time, if the payments are actually purchase payments to the selling C-corporation, the payments will face double taxation, once at the corporate level and again upon distribution as dividends.

In H&M, Inc. v. Commissioner, T.C. Memo 2012-290 (October 15, 2012), H&M, Inc. agreed to sell its insurance business to a local bank and competitor.  Under the purchase agreement, H&M agreed to sell “all files, customer lists, insurance agency or brokerage contracts, the name of [the insurance business], and all the goodwill of [the insurance business]” for $20,000.  The deal was contingent upon the agreement by H&M’s owner – Mr. Schmeets – to work for the buyer for six-years and also enter into a covenant not-to-compete for a period of 15 years.  Under these latter agreements, Schmeets would receive over $600,000 during the six years.  The agreement was later modified, so that some of the compensation would be deferred, would earn interest, and would be payable to Schmeets’ estate in the event that Schmeets died.

The Court found that there had been no appraisal of H&M’s assets prior to entering into the agreement.  In fact, the buyer didn’t even examine H&M’s financial records.  In addition, prior to the sale, H&M had paid Schmeets a salary of about $29,000 per year.

The IRS argued that Schmeets’ wages were actually disguised payments to H&M for the sale of the business and urged the Court to apply the “substance-over-form doctrine” to recharacterize the transaction.

While lamenting the parties’ failure to adequately document the transaction, the Tax Court rejected the IRS’ position.  To demonstrate that the business was worth more than $20,000, the IRS would need to show that the assets were undervalued.  But the only intangible that the IRS pointed to as being undervalued was the goodwill of the business.

Generally, there is no salable goodwill where the business depends upon the personal relationships of a key individual, unless there is an agreement that prevents that individual from taking his relationships, reputation and skills elsewhere.  Here, “there was convincing testimony that . . . . no one knew insurance better than Schmeets.”  Furthermore, Schmeets had no agreement with H&M (of which he was the sole owner, incidentally) that would have prevented him from going to work elsewhere.  Thus, the business’ goodwill had no value.

The Court also gave “no weight” to the opinion of the IRS’ expert, who opined that Schmeets’ new salary was excessive, since the expert ignored Schmeets’ particular skills and level of experience.

Finally, the Court noted that, in negotiating the sale and related agreements, there was “virtually no discussion” about the tax consequences of the transaction.  The employment relationship was motivated by Schmeets’ desire for guaranteed employment and the buyer’s desire to harness his skills, not for “massaging the paperwork for its tax consequences.”