Are Parallel Imports a Privilege or Disaster?

The term “parallel imports” (also known as “gray imports”) refers to genuine branded goods obtained from one market (i.e., a country or economic area) that are subsequently imported into another market and sold there without the consent of the trademark owner.

The parallel imported goods are genuine (as distinct from counterfeit goods) in that they have been manufactured by or for or under license from the brand owner. However, they may have been formulated or packaged for a particular market, but then imported into a market not intended by the brand owner.

Exhaustion of IP rights refers to how IP right holders may control the distribution of their branded goods. According to the concept of exhaustion, once an IP rights holder sells in a particular market a product to which its IP rights are attached, it must allow the resale of that product in that market. It is deemed that the IP rights covering the product have been “exhausted” by the first sale.

There are two types of exhaustion regimes: national (or regional) and international. The debate as to which is preferable has been highly controversial.

National (or Regional) exhaustion is the regime that, once a brand owner has sold goods in relation to which the trademark is used in a particular country, it has only “exhausted” its trademark rights with regards to those goods in that particular country. If the same goods are subsequently sold in another country, the brand owner may rely on its trademark rights in that other country to prevent the further sale of the goods (absent consent to such subsequent sale). In some areas of the world, particularly in the EU, this concept applies regionally, that is, across a group of countries which form part of a single trading area.

International (Global) exhaustion is the regime that, once a brand owner has sold goods concerning which the trademark is used somewhere in the world, it has exhausted its trademark rights in relation to those goods everywhere in the world.

Some countries use a hybrid approach that modifies one of the two basic types of exhaustion.

For example, they may nominally apply the principle of international exhaustion with some certain restrictions (material differences approach).

The debate over parallel importation focuses on the extent to which a trademark owner should be able to maintain control over its own brands by using its trademark rights in a country (or a region) to restrict the importation of goods into that country (or region) after the goods have been put on the market somewhere else by the trademark owner, or with its consent, or by another person (whether or not related to the owner) who owns the rights in the jurisdiction where the goods originated. In other words, a discussion is held over which exhaustion regime to apply in a specific country. Ukraine has been an active participant of the debate over recent years.

Effective Ukrainian legislation does not explicitly determine a certain IP exhaustion regime. However, the current jurisprudence tends to apply the international one with regard to trademarks. Thus, as a general rule, currently parallel imports of genuine products into Ukraine shall not be deemed a trademark infringement.

At the same time, according to the Trademark Law, a trademark holder may prohibit the use of its trademark on parallel imported products if upon the first sale the condition of the product has changed or worsened. In addition, parallel importation of the pharma and crop protection products to Ukraine is prohibited unless the parallel imported products have valid market authorization in Ukraine.

The first and foremost function of the trademark is to indicate the trade origin or source of the goods in relation to which it is used, thereby enabling consumers to distinguish the goods of one trader from those of others. A trademark also serves to guarantee quality. If consumers like the goods to which the mark is applied, they will buy more. If the quality is consistent, the trademark will represent that quality and hence goodwill is generated, which in turn enhances the value of the trademark. Thus, a trademark symbolizes the goodwill which a trader has in the goods.

Brand owners often design their products, packaging, sales and distribution networks to meet specific cultural, language, environmental and other conditions in specific countries. They may also authorize particular distributors in those countries, who earn royalties on the sales, often on the basis that they will provide warranties or after sales service, or local marketing or information activities.

As proceeds from the above, goodwill is built up differently in each country where the trademark is used. Thus, it is inherently illogical to say that the goodwill is “exhausted” in every country once the mark has been used in just one of them.

Parallel importers generally acquire genuine goods in one jurisdiction, and then import them into another jurisdiction, undercutting in price the trademark owner or authorized distributor. They may be able to undercut the price due to various reasons, including having acquired the product from a jurisdiction where it is sold at a lower price (usually because of differing local economics and sometimes also because of differing quality); or because they do not invest in product research and development or the provision of warranties, guarantees, after sales service, promotion, marketing and information distribution, and/or do not need to support distribution networks.

Brands provide a number of important benefits for consumers: the brand is the “face” of a product, recognizable by consumers and indicating qualities they have come to expect and trust. Brand owners, therefore, have a big stake in ensuring that their brands are associated with high-quality and a good buying experience. That is, in protecting the goodwill associated with the brand. Brand owners invest in their brands, and the protection of their brands, in order to ensure this.

In addition, brand owners invest in the promotion, development and protection of their brands to attract consumers with the benefits described above. In the same way, they invest in R&D and maintenance of quality on their products which are marketed under the brand. When brand owners have built, with this investment, a valuable brand with good consumer association, they are encouraged to expand into new markets which may not otherwise be serviced, including R&D into the best product formulations or specifications for the new market. Brand extension into new products also receives investment, to the benefit of consumers.

If the return on this investment is undermined by parallel imports, the investment will inevitably fall away, leaving:

•  less choice and availability for consumers;

•  less R&D for new products and a consequential slowdown in innovation;

•  less expansion into new geographic markets (especially those where global exhaustion prevails); and

•  less trade and the benefits associated with it.

It is a common misconception that parallel imports are always cheaper for consumers than the goods marketed directly by the brand owner, but research shows this to be an oversimplification.

The pricing policy of brand owners reflects their past and future investment. It must necessarily reflect the investment made in R&D, marketing and distribution (all benefits for the consumer), not just the base price of producing the product. Parallel importers do not need to reflect such investment. They “free ride” on the investment put in by the brand owners.

Local distributors for the brand owner may also be adversely affected, having negotiated to pay a royalty to distribute the brand owners’ product on a certain territory, and having invested in local marketing, information and provision of after-sales service or warranties, only to find competition from a parallel importer who provides none of this investment or service for consumers. Consumers may be misled into believing that the authorized distributor will honor warranties or provide after-sales services for goods with which it, in fact, has no sales connection.

Studies also show parallel imported goods are often mixed or entwined with counterfeit goods. The counterfeits are “hidden” among genuine products. Cases are not often reported, since businesses that are “caught” using counterfeit goods, when they thought they had simply got a good deal on some gray goods, will generally admit liability in the face of action by brand owners and reach a confidential settlement to avoid embarrassment.

The channels of trade for parallel imported goods are ideal for counterfeiters. Brand owners ship through regular shipping agents and ports where customs officials have knowledge of the agents and have experience with regular shipments. Both parallel importers and counterfeiters avoid such regular routes and benefit from confusion by using multiple different ports and agents.

It has been calculated that billions of US dollars in revenue are lost worldwide every single year to gray market diversion, along with other possible damage, such as negative consumer experiences that damage the goodwill and reputation of a brand and issues surrounding consumer protection, product integrity, service and warranties, and recall notifications. While reducing revenue for brand owners, gray markets can capitalize on surplus inventory, lower manufacturing costs, lower distribution costs, current economic conditions and currency exchange rates by facilitating the export of goods without the brand owner’s permission. Gray market diversion undercuts the prices of authorized domestic distributors through the sale of goods at lower price points.

At the end of 2019, the Law On Amendments to the Customs Code Regarding Protection of Intellectual Property Rights at the Customs Border came into effect. It introduced, inter alia, a completely new approach to how customs treat parallel imports.

Previously, a customs officer had to suspend customs clearance and notify a trademark owner of any product spotted containing a trademark recorded with the Customs IP Registry being imported without the authorization of the trademark owner. It was the trademark holder who decided on whether to initiate a trademark infringement action (based on either assumed counterfeiting or parallel imports or copycats).

Now it is the sole discretion of a customs officer as to whether to suspend customs clearance of the product, which allows the Customs Service to release counterfeits, copycats and parallel imported goods even without notification of the respective trademark owner. Such an approach by the customs authorities is beneficial to the international exhaustion regime and apparently supports parallel imports coming into the country.

There is currently no international treaty or consensus dictating a standard of national (or regional) exhaustion, or international exhaustion. The Paris Convention does not address the issue. The Agreement on Trade Related Aspects of Intellectual Property (TRIPs) is deliberately neutral on the subject. Article 6 of TRIPs reads: “For the purposes of dispute settlement under this Agreement nothing in this Agreement may be used to address the issue of the exhaustion of intellectual property rights.”

Remedies for gray market goods are country specific. In Ukraine a trademark owner can mitigate the importation and sale of gray market goods through, inter alia, the following means:

•  Reviewing the company’s businesses supply chain, including licensee and distributor agreements, and create wording to address parallel importation (e.g., insert provisions prohibiting exports of products to certain jurisdictions, etc.).

•  Drafting manufacturer’s warranties to limit the ability of purchasers of gray market goods to rely on those warranties unless they return the goods to the place of original purchase.

•  Collecting information on the source of gray market activity through both internal and external sources (e.g., sales personnel, related entities located in other countries, vendors).

•  Educating the company’s consumers about known parallel imports and the differences to look for in those imports (e.g., different packaging, absence of the manufacturer’s original warranty).

•  Registering trademarks and copyrights, record trademarks with the IP Customs Registry, filing complaints against parallel imported goods with consumer protection and local certifying authorities, creating an online system for reporting violations, etc.

The Ukrainian Law Firms 2021. A Handbook for Foreign Clients.