U.S. Supreme Court Clarifies and Simplifies Standards for Ability to Bring Section 43(a) False Advertising Claims

High Court Resolves Circuit Split on “Prudential Standing” to Bring False Advertising Claims Under the Lanham Act:  Lexmark Int’l, Inc. v. Static Control Components, Inc., No. 12-873 (2014)

In what has become rare in recent years, the Supreme Court issued a unanimous opinion, this one deciding the proper test for what is often called “prudential” standing  to bring a false advertising claim under Section 43(a) of the Lanham Act, 15 U.S.C. § 1125(a).  Writing for the Court, Justice Scalia considered the three different tests applied by the various circuit courts of appeal, and dismissed them all in favor of a standard reminiscent of law school torts class:   “To invoke the Lanham Act’s cause of action for false advertising, a plaintiff must plead (and ultimately prove) an injury to a commercial interest in sales or business reputation proximately caused by the defendant’s misrepresentations.”

Background

This decision arose against the backdrop of longstanding legal animosity between Lexmark, a manufacturer and seller of laser printers and ink and toner cartridges, and Static Control Components (“Static”), a manufacturer and supplier of parts and components that other companies – printer cartridge “remanufacturers” – need to refurbish used Lexmark cartridges, and re-sell them in competition with Lexmark.  Notably, Static does not, itself, remanufacture or sell cartridges in competition with Lexmark.  To combat unwanted competition from Static’s clients, Lexmark instituted a “Prebate” program whereby Lexmark offered customers 20% off new cartridges if they agreed to return their empty cartridges to Lexmark (who could then, itself, refurbish and re-sell them).  The Prebate terms were included in a typical “shrinkwrap license” agreed to by customers by opening the cartridge box, and Lexmark enforced the terms by installing a microchip in each Prebate cartridge that would disable the cartridge once empty.  Static, however, developed a workaround – its own microchip that mimicked Lexmark’s Prebate microchip, allowing its remanufacturer customers to override Lexmark’s control mechanism and continue refurbishing and reselling Lexmark cartridges.

In 2002 Lexmark sued Static for copyright infringement, and Static counterclaimed for, among other things, false advertising on the theory that (1) Lexmark misled cartridge end-users into believing they were legally bound by the Prebate terms, and (2) that Lexmark sent letters to remanufacturers stating that it was illegal to sell refurbished cartridges using Static’s components.  Static asserted that Lexmark’s purportedly false statements resulted in diverted sales and injury to its business reputation.  The District Court dismissed Static’s claims for lack of “prudential standing,” but the Sixth Circuit reversed, noting the existence of three competing tests for “prudential standing” used throughout the federal courts – the “antitrust standing” test, the “actual competitor” test, and the “reasonable interest” test.  The court adopted the Second Circuit’s “reasonable interest” approach, which states that a claimant has standing if he can demonstrate “a reasonable interest to be protected against the alleged false advertising” and “a reasonable basis for believing that the interest is likely to be damaged by the alleged false advertising.”

The Supreme Court Steps In

Justice Scalia, writing for the Court, began his analysis by explaining that “prudential standing” is not really standing at all, but rather is a question of whether, pursuant to the text of a statute, a particular plaintiff has a right to sue.  The Court therefore turned to two familiar principles: the “zone of interest” and proximate causation.  Justice Scalia explained that determining who falls within the “zone of interest” of the law invoked varies by statute, but is generally a low bar, in that a claimant’s interest simply cannot be “marginally related to or inconsistent with” the purposes of the statute invoked.  In the case of the Lanham Act, the interests to be protected are expressly stated in the law’s statement of purpose: “to protect persons engaged in [ ] commerce against unfair competition,” which is “understood to be concerned with injuries to business reputation and present and future sales.”  Accordingly, the Court held that to come within the zone of interest of § 1125(a), a plaintiff must allege “an injury to a commercial interest in reputation or sales.”

Next, the Court explained the time-tested “proximate cause” standard. Noting that the analysis will be controlled by the nature of the cause of action, the Court explained that proximate causality asks “whether the harm alleged has a sufficiently close connection to the conduct the statute prohibits”; that is, the harm cannot be “too remote” from the defendant’s conduct and cannot be “purely derivative” of injuries to third persons.  In making a critical distinction between injury to consumers and injury to claimants, Justice Scalia explained that, in a sense, “all commercial injuries from false advertising are derivative of those suffered by consumers who are deceived by the advertising; but since the Lanham Act authorizes suit only for commercial injuries, the intervening step of consumer deception is not fatal to the showing of proximate causation required by the statute.”  Thus, the Court held that a § 1125 plaintiff “must show economic or reputational injury flowing directly from the deception wrought by the defendant’s advertising; and that that occurs when deception of consumers causes them to withhold trade from the plaintiff.”

Applying this new two-factor test (in lieu of the three alternatives followed by the various circuits and all rejected by the Supreme Court for various reasons), the Court concluded that Static is a plaintiff authorized to sue under § 1125.  First, the Court concluded that Static’s alleged injuries – lost sales and damage to business reputation – are “precisely the sorts of commercial interests the [Lanham] Act protects” and that Static plainly fell within the zone of interest.  Second, the Court held that Static sufficiently alleged that its injuries were caused by Lexmark’s statements because it claimed that Lexmark disparaged its business and products by claiming that Static’s business was illegal, and that Static’s injury “flows directly from the audience’s belief in the disparaging statements.“  This was true, the Court explained, even though Lexmark and Static are not direct competitors because causation of reputational injury from disparagement does not require competition “even if the defendant’s aim was to harm its immediate competitors, and the plaintiff merely suffered collateral damage.”  Also, because Static’s microchips had no other use than in refurbishing Lexmark cartridges, “any false advertising that reduced the remanufacturers’ business necessarily injured Static Control as well.”  Static was therefore entitled to an opportunity to have its day in court.

The Impact of the Court’s Decision

The Supreme Court’s decision in Lexmark will have different impacts in different jurisdictions.  The most prominent effects will likely be seen in the Seventh, Ninth, and Tenth circuits, which had applied the categorical “actual competitor” test, and in the Second Circuit, which had applied the more amorphous “reasonable interest” approach.  Specifically, in “actual competitor” jurisdictions, false advertising plaintiffs will now have an easier time establishing their right to sue under § 1125(a) since they will no longer be compelled to show direct competition with the defendant, potentially giving plaintiffs at different rungs of the commercial chain more vertical mobility in terms of choosing their targets.  By contrast, in the Second Circuit, false advertising plaintiffs may find themselves more confined by what is arguably a more black-and-white standard.  The two Lexmark factors essentially tighten the respective factors of the Second Circuit’s existing test, changing “reasonable interest” to be protected to “zone of interest” and “reasonable basis” for damage to “proximate cause.”  As a practical matter this may not foreclose all that many plaintiffs from seeking relief, but potential victims of false advertising seeking their day in court should be sure to clarify their pleadings to reflect the high court’s new requirements.