SCOTUS Clears District Court Jam Over Test for Standing in False Advertising Cases

Printing has not been this interesting since Dwight Schrute and Jim Halpert bickered over paper sales and Michael Scott told off-color jokes in “The Office.”

Last week, the U.S. Supreme Court stepped into the laser printer wars, and in the process shook up false advertising law by opening the courtroom doors to more potential plaintiffs. Lexmark Int’l, Inc. v. Static Control Components, Inc., ___ S.Ct. ____, 2014 WL 1168967 (Mar. 25, 2014). While the courts have unanimously agreed that an individual consumer does not have standing to bring a claim for false advertising under the Lanham Act, 15 U.S.C. §1125(a), the question of whether anyone other than a direct competitor may bring such a claim has remained unsettled.

Different articulations of the appropriate test for standing have led to inconsistent results, and a circuit split. In Lexmark, the Court examined whether a supplier of parts to toner cartridge refurbishing companies may have standing to bring a claim for false advertising against a direct competitor of the refurbishers and in finding in the affirmative, clarified the test for determining standing in all cases under that provision of the statute. At the same time, by elevating a “proximate cause” requirement, the Court has reemphasized the key role that proof of actual consumer deception plays in Lanham Act cases.

Background
Lexmark is a manufacturer of proprietary toner cartridges for its printers. To protect its market against “remanufacturers” who refurbish its cartridges for sale, Lexmark developed a microchip designed to prevent reuse unless the cartridge was returned to Lexmark for processing. In response, Static Control began making a competing microchip for the remanufacturers. Lexmark sued, alleging that the microchip infringed its copyright.

Static Control counterclaimed that Lexmark engaged in false advertising by (i) misleading consumers into thinking that they were legally required to return the cartridge to Lexmark after a single use and (ii) writing to remanufacturers and falsely telling them that it was illegal to refurbish the cartridges in general and to use Static Control’s microchip for that purpose in particular.

The District Court granted Lexmark’s motion to dismiss the Lanham Act counterclaim on the grounds that Static Control did not have “prudential standing” to bring the claim, because it was not a direct competitor of Lexmark and its injury, a byproduct of the competition between Lexmark and the remanufacturers, was remote. Static Control Components, Inc. v. Lexmark Int’l, Inc., 2006 WL 7347975 (E.D. Ky. 2006). The 6th Circuit reversed. Static Control Components, Inc. v. Lexmark Int'l, Inc., 697 F.3d 387 (6th Cir. 2012). After canvasing the various approaches to standing followed by the circuits, it applied the “reasonable interest” test followed by the 2nd Circuit and concluded that Static Control’s business reputation and sales to manufacturers constituted a reasonable interest and that Lexmark’s statements about illegal conduct sufficiently alleged harm to those interests. With the circuits in conflict, the Supreme Court granted certiorari to decide the appropriate analytical framework for determining standing in a false advertising claim under the Lanham Act.

And then decided that everyone was wrong.

The decision
Justice Scalia, writing for a unanimous Court, first noted that the plaintiff met the threshold for constitutional standing under Article III, as there was a sufficient “injury in fact” fairly traceable to Lexmark’s actions, and thus a “case or controversy” within the federal courts’ jurisdiction. Neither party had argued to the contrary; nevertheless, Justice Scalia used this “finding” as a springboard to launch into a lengthy discussion of what “standing” is not.

He began by rejecting outright the parties’ characterization of the issue as one of “prudential standing”, observing that the very idea of a standing requirement over and above Article III standing—based on the prudence of federal judges—was at odds with the principle that a federal court’s duty to hear cases within its jurisdiction is “virtually unflagging.” Not ready to completely eliminate a court’s discretion, however, Justice Scalia reframed the question as one of statutory interpretation (which he grudgingly acknowledged had sometimes been called “statutory standing”). That is, when interpreting whether a plaintiff can bring a claim under the Lanham Act, courts are required to determine whether the plaintiff “falls within the class of plaintiffs whom Congress has authorized to sue under §1125(a).”  

According to the court, the Lanham Act’s broad language, authorizing suit by “any person who believes that he or she is likely to be damaged” by the defendant’s false advertising, is limited by two background principles—the interests of the plaintiff must “fall within the zone of interests protected by the law invoked,” and the injuries to the plaintiff must be “proximately caused by violations to the statute.” 

The zone of interest for false advertising claims is derived from the statement of the statute’s purposes set forth in 15 U.S.C. §1127 and requires an allegation of “an injury to a commercial interest in reputation or sales.” This would exclude consumers themselves, and also businesses directly misled by the false advertising.

Justice Scalia’s brief, four-paragraph discussion of proximate harm bears some attention. Proximate cause, he noted, entails an examination of the closeness of the alleged harm to the conduct prohibited by the statute. But the Lanham Act presents an inherent problem: the injury the statute seeks to remedy is never the injury most closely linked to the false advertising. The most direct injury is suffered by the consumers deceived by the false advertisement, but as the zone of interest analysis confirmed, that injury is not within the scope of the statute. The question then became whether injuries suffered by others would be too remote to remedy.

The Court held that even though “all commercial injuries from false advertising are derivative of those suffered by consumers who are deceived by the advertising,” “the intervening step of consumer deception is not fatal to the showing of proximate causation required by the statute.” The Court then stated that “a plaintiff suing under §1125(a) ordinarily 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.” Note, then, that consumer deception is always a necessary factor in the analysis, in order to maintain the causal link.

Justice Scalia next examined the tests proposed by the parties and those adopted by the circuits and rejected them all. The balancing test advocated by Lexmark and applied by the 3rd, 5th, 8th and 11th Circuits looked to five factors to determine standing, leading in the Court’s view to “unpredictable and at times arbitrary results.” The first three factors related to the zone of interest and proximate cause and hence were requirements for standing, not mere factors. The second two—the “speculativeness” of the damages claim and the risk of duplicative damages or complexity in apportioning damages—were inappropriate because a Lanham Act plaintiff, unable to quantify its losses sufficiently well to obtain damages, may still obtain an injunction or disgorgement of defendant’s profits.

While the test limiting standing to direct competitors of the defendant, applied by the 7th, 9th and 10th Circuits, had the virtue of clarity, the Supreme Court believed that it took too narrow a view of unfair competition as it developed in the common law and was incorporated into the Lanham Act. Finally, the reasonable interest test applied by the 6th Circuit below was seen as too vague and straying too far from the principles of the zone of interest encompassed by the Act and proximate harm.

Applying only the two guiding principles of the zone of interest and proximate harm, with no rigid or formulaic test as guidance, the Court found that Static Control had standing to bring its claim. Its alleged injury—lost sales and damage to business reputation—were commercial interests protected by the Lanham Act. Although this was not a classic case of direct injury by a competitor, the Court held that Static Control also alleged proximate causation. First, the damage to Static Control’s reputation flowing directly from Lexmark’s statements that Static Control’s business and products were illegal. As the Court held, “[W]hen a party claims reputational injury from disparagement, competition is not required for proximate cause; and that is true even if the defendant’s aim was to harm its immediate competitors, and the plaintiff merely suffered collateral damage.” Second, because Static Control’s chips were necessary for, and had no other use than, refurbishing Lexmark toner cartridges, “in these relatively unique circumstances” injury to remanufacturers was tantamount to injury to their supplier.

What it means
The decision eliminates the variable standards formerly in effect in different circuits, thereby lessening forum shopping by plaintiffs and, depending on the circuit, broadening or in some cases narrowing which non-competitors may bring a false advertising action under §1125(a). Also, somewhat tantalizingly, the decision suggests that as courts apply the new focus on proximate cause to false advertising cases generally, it may affect the courts’ approach to how plaintiffs must show consumer deception.

First, the decision may open the door to certain non-competitors who have commercial interests at stake. However, given the lack of clear guideposts in the decision as to how to apply the zone-of-interest/proximate cause approach, it is not clear that many of the leading cases in the Circuit Courts of Appeal would have come out differently under the new Lexmark standard. For instance, in Conte Bros. Automotive, Inc. v. Quaker State-Slick 50, Inc., 165 F.3d 221, 233-34 (3d Cir. 1998), the 3rd Circuit found that retailers of motor oil had no “prudential standing” to sue defendant, a manufacturer of motor oils. Under the Lexmark standard, a court might find that the retailers were in the “zone of interest” because they had alleged lost sales due to defendant’s conduct, but it is not clear that the injury was proximately caused by the false advertising. A court could find that the immediate cause of the retailers’ loss of sales to other retailers was attributable to some other factor—for example, that the other retailers stocked a brand of motor oil that plaintiffs did not.

Similarly, in L.S. Heath & Son, Inc. v. AT&T Information Systems, Inc., 9 F. 3d 561, 575 (7th Cir. 1993), Heath (a chocolate manufacturer) voluntarily participated in an AT&T ad touting its use of AT&T computers, but then alleged the advertising was false when the computer system experienced problems. The 7th Circuit rejected the claim because the companies were not direct competitors, but probably would have reached the same conclusion under the Lexmark analysis because Heath did not show how its appearance in the AT&T ad would affect its chocolate sales or its reputation among consumers as a chocolate manufacturer.

Second, the Supreme Court has firmly put to rest any lingering notion that there can be consumer class actions under Section 43a. Consumers simply are not in the zone of interest protected by the Lanham Act because they cannot assert “an injury to a commercial interest in reputation or sales” caused by an advertiser’s alleged false advertising.

Finally, the decision makes clear that the role of proximate cause in a false advertising case cannot be downplayed, and this in turn serves to underscore the fundamental importance of proving consumer deception. While the Lexmark case was decided on appeal from a motion to dismiss, it is possible that the Supreme Court’s emphasis on establishing causal linkage—from the false or misleading statement, to consumers being deceived by that statement, to third parties being harmed by the consumer deception—could even affect the willingness of the lower courts to rely on the presumptions of consumer deception that have been traditionally applied in cases of literal falsity, especially in cases where it is more difficult to draw the line between a literal falsehood and a misleading statement, such as advertisements falling into the category of “false by necessary implication.”