This article was originally published by World Trademark Review on December 16, 2020. It has been republished with permission.
The recent appeal decision Costco Wholesale Canada Ltd. v Simms Sigal & Co. Ltd. constitutes a win for distributors whose rights under an exclusive distribution agreement are knowingly undermined by third parties selling grey market goods. The Quebec Court of Appeal confirmed that exclusive distributors can claim extra-contractual liability against grey marketers based on the civil law fault of “contractual inference” with an award of punitive damages in certain circumstances.
Background to Costco Wholesale Canada Ltd. v Simms Sigal & Co.
Simms Sigal & Co. Ltd. (Simms), a Canadian business specializing in the import and distribution of high-end clothes, had exclusive distribution agreements with American manufacturer R&R, owner of the ROCK & REPUBLIC trademark. Simms distributed the R&R products to first-class retail departments and clothing stores in Canada that sold R&R jeans for $250 to $325. In 2009, Costco Wholesale Canada Ltd. (Costco) agreed that Kontakt US International Inc. would buy R&R merchandise and sell it to Costco through the distribution company Abfi Inc., resulting in Costco selling the R&R jeans in Canada for $98.99.
Upon learning of this situation, Simms sent cease and desists letters to Costco asking that it stop selling the R&R products and specifying that Simms was the exclusive distributor of R&R products in Canada. Simms also highlighted to Costco that the R&R products it was selling held Simms’s CA number under the Textile Labelling Act. Costco responded that it was entitled to sell these goods since they constituted authentic goods bought on the grey market. In this regard, Costco had received through Abfi Inc. a letter signed by R&R confirming the authenticity of the goods purchased and clarifying that R&R was dealing with Simms.
On the day that Simms communicated to Costco its intention to initiate proceedings, R&R issued Simms a notice of termination of their exclusivity agreement alleging breach of contract. R&R filed in front of the US Bankruptcy Court a Motion to reject the exclusive distribution agreement, which was granted by the Court following the withdrawal of its opposition by Simms. Simms reached a settlement for damages in the sum of $2,700,000 USD.
Costco’s extra-contractual responsibility
The Court of Appeal confirmed in its judgment the Superior Court’s analysis that, because Simms had no contractual relationship with Costco, Simms’s claim was necessarily one of extra-contractual liability (art. 1457 CCQ). In this regard, the Superior Court explained that there can be an exception to the civil law principle that contracts only bind the contracting parties (art. 1440 CCQ) when there is a fault of “contractual interference”, such as when a third-party interferes in a contractual relationship. Three elements must be present to determine if a third party, like Costco, has interfered in a contractual relationship, such as the one between Simms and R&R, namely:
- Knowledge by the third party of the contractual rights;
- Encouraging or participating in the violation of the party’s contractual obligations; and
- Bad faith or disregard of the other’s interests.
Regarding the first criteria, it is not necessary that the third party see a copy of the contract, just that it be aware of it. In this case, Costco was aware of the exclusive distribution agreement between Simms and R&R because (1) Simms had clearly mentioned the exclusive distribution agreement in its cease and desist letters to Costco, (2) Costco was aware that it was selling R&R products with Simms’s CA number, (3) Costco had no reason to believe that R&R had resolved the matter with Simms despite dealing with a trusted intermediary, and (4) the experienced buyers at Costco ought to have known that such products sold in high-end boutiques would be the subject of an exclusive agreement. As such, Costco was negligent in willingly choosing to ignore the existence of the distribution agreement.
Regarding the second and third criteria, the main question is whether the third party had knowledge of the contract it was infringing in a way that it knew was detrimental to one of the contracting parties. As such, the Court of Appeal focuses on the fact that Costco continued to make orders for R&R merchandise after it was made aware of the existence of the exclusivity agreement. Additionally, the Court of Appeal reiterates the trial judge’s finding that Costco could not ignore the negative impact of its sales of R&R products on Simms. In fact, Costco was selling the jeans at a third of the retail price of those of Simms, which inevitably caused Simms to lose credibility and reputation amongst its retailer clients, and to incur financial damages.
The Court of Appeal also confirmed the Superior Court’s granting of punitive damages against Costco for intentionally violating Simms’ right to its reputation under the Charter of Human Rights and Freedoms. While the Court of Appeal reiterates that the granting of punitive damages remains an exceptional remedy, Costco’s actions justified the award of punitive damages: it was informed multiple times that its actions caused Simms severe damages and harmed its reputation; Costco is a sufficiently specialized retailer that it ought to have known of the impact of its actions on Simms’ reputation; Costco was aware that it was selling clothes with Simms’ CA number (contrary to the labelling law); and Costco refused to reveal that the goods originated from R&R, despite having received a confirmation letter to that effect.
The Court of Appeal also confirms that the Superior Court’s award of $500,000 in punitive damages was justified pursuant to the relevant criteria (art. 1621 CCQ), namely the importance and gravity of Costco’s actions, the size of Costco’s business, and Costco’s “treasure hunt effect” marketing strategy to deliberately attract customers and increase its sales by selling the R&R jeans at a third of the price. Additionally, the Superior Court judge had taken into consideration in its assessment the compensatory damages it awarded, as well as the damages that had been granted by the American tribunal.
Exclusive distributors have recourse under Quebec civil law against grey marketers that knowingly interfere with their exclusive distribution agreements. Punitive damages can be awarded in cases where the interference constitutes a “conscious and callous disregard for the exclusive distributor’s reputation”.
For more information on upholding rights under an exclusive distribution agreement, please reach out to Smart & Biggar’s IP Litigation & Enforcement team.
The preceding is intended as a timely update on Canadian intellectual property and technology law. The content is informational only and does not constitute legal or professional advice. To obtain such advice, please communicate with our offices directly.