On Tuesday, July 29, the United States Court of Appeals for the Second Circuit “clarified certain aspects of [its] false advertising jurisprudence” and held that, where literal falsity and deliberate deception have been proved in a market with only two players, it is appropriate to use legal presumptions of consumer confusion and injury for the purposes of finding liability in a false advertising case brought under the Lanham Act.^[1]

1.  Background and Procedural History

The nutritional ingredient involved in this litigation is a dietary ingredient called folate, a B vitamin that helps the body make new cells.  Folate is considered to be a critical supplement for prenatal health, and low folate intake is associated with various vascular, ocular neurological and skeletal disorders, and may pose a serious risk to individuals with diabetes.

Since 2002, Merck & Cie (“Merck”)^[2] manufactured and sold a folate product under the name “Metafolin” to customers who utilize it in finished products for resale, such as vitamins and supplements.  Metafolin is comprised of a naturally occurring, biologically active form of Methyltetrahydrofolate (“5-MTHF”).  Merck was the first company to manufacture a pure and stable stereoisomer of L-5-MTHF, a 6S Isomer Product, as a commercial source.  Metafolin was the product of decades of research and the investment of tens of millions of dollars.  It is one of Merck’s most important products.

In 2006, Gnosis S.p.a. and Gnosis Bioresearch S.A. (collectively, “Gnosis”) started making a folate product named “Extrafolate,” a tetrahydrofolate that is a mixture of the R isomer and the S isomer, or a D-5-MTHF product.  D-5-MTHF does not occur in nature and does not have the same nutritional benefits to humans as Merck’s L-5-MTHF product. Because it is a mixed product, Extrafolate sells at a much lower price than Metafolin.

In the predominant naming conventions of compounds, isomers are labeled with either a “D” or an “L” based on the isomer’s relation to the glyceraldehyde molecule or “R” and “S” based on the isomer’s relation to the carbon atom. In the context of folates, “S” or “L” refers to the naturally occurring isomer, and “R” or “D” refers to the non-natural isomer. If manufactured synthetically, a folate is “mixed” and would be identified as having both “D” and “L,” or “R” and “S,” and thus be labeled as either “D,L” or “R,S.”

Between 2006 and 2009, Gnosis printed various types of marketing materials, including brochures and product specification sheets, using chemical descriptions, terms, and formulas attributed to the pure 6S isomer for the sale and marketing of its 6R,S mixture product. Gnosis sold its product to six customers, both directly and indirectly, during this time.  In 2007, Merck sued Gnosis, accusing it of falsely advertising Extrafolate by using the pure Isomer Product chemical name and properties in marketing Extrafolate.

Following a bench trial, the Southern District of New York determined that Merck had established Gnosis’ liability for false advertising under Section 43(a) of the Lanham Act,^[3] and awarded damages, prejudgment interest, and attorney’s fees and imposed a corrective advertising injunction.

2.  The Court’s Decision

The Second Circuit affirmed both the district court’s finding of liability under the Lanham Act and the relief awarded.  On appeal, Gnosis challenged the district court’s conclusion that consumer confusion and injury could be presumed in light of its factual findings.  Gnosis also argued that the district court erred in awarding Merck all of Gnosis’ profits and further erred by awarding enhanced damages by trebling the amount of profits.

Liability under the Lanham Act

As background, the Second Circuit explained that “[t]o establish false advertising under Section 43(a) of the Lanham Act, 15 U.S.C. § 1125(a), the plaintiff must first demonstrate that the statement in the challenged advertisement is false.  A false advertising claim may be based on one of two “theories.”  Tiffany (NJ) Inc. v. eBay Inc., 600 F.3d 93, 112 (2d Cir. 2010).  “Falsity may be established by proving that (1) the advertising is literally false as a factual matter, or (2) although the advertisement is literally true, it is likely to deceive or confuse customers.”  S.C. Johnson & Son, Inc. v. Clorox Co.,241 F.3d 232, 238 (2d Cir. 2001) (internal quotation marks omitted).

The Court then turned to the district court’s application of the consumer confusion presumption.  The Second Circuit noted that a Lanham Act plaintiff may prove actual consumer confusion or deception resulting from the violation, or that a defendant’s actions were intentionally deceptive thus giving rise to a rebuttable presumption of consumer confusion, in order to receive an award of damages.  The court noted upheld the trial court’s finding that the majority of Gnosis’ challenged marketing materials were literally false because they used the common name for the pure 6S isomer product (rather than the “mixed” nomenclature) to discuss and advertise Extrafolate, a mixed product.^[4]  The Second Circuit explained that when a defendant’s advertising of products is literally false, a Lanham Act plaintiff need not “provide evidence of actual consumer confusion by resort to witness testimony, consumer surveys, or other such evidence in order to establish entitlement to damages under the Lanham Act.^[5]

In light of the finding of literal falsity, the Second Circuit upheld the district court’s presumption of consumer confusion resulting from Gnosis’s marketing specification sheets, brochures, data sheets, and certificates of analysis.^[6]  It explained that, once literal falsity – here, an unchallenged factual finding – was proved, no further evidence of actual consumer confusion was necessary.

The Second Circuit upheld the district court’s finding of implied falsity as well.  It  reviewed the chemical description of the pure isomer in brochures, material safety data sheets, and certificates of analysis, and concluded that while the description was literally true “when applied to the pure product,” it was used in a manner that was intended to mislead consumers as to the mixed product Gnosis was actually selling.  It explained that the record readily supports the conclusion that “a significant number of consumers” were misled by Gnosis’s false labeling, noting that Gnosis had failed to demonstrate an absence of confusion is adequately supported by the record.^[7]  Thus, based upon the findings of literal falsity and the “egregious nature” of Gnosis’s deliberate intent to deceive the purchasing public, the Second Circuit noted that the imposition of a presumption of consumer confusion was appropriate.

Based upon its finding of literal falsity, the district court determined that injury to Merck could be presumed.  The Second Circuit affirmed, rejecting Gnosis’ argument that a presumption of injury is applicable only in cases involving comparative advertising mentioning the plaintiff’s product by name.  Previously, the Second Circuit had held that in cases involving misleading, non-comparative commercials which touted the benefits of the products advertised but made no direct reference to any competitor’s product “‘some indication of actual injury and causation’ would be necessary in order to ensure that a plaintiff’s injury is not speculative.”^[8]  By comparison, injury could be presumed in false comparative advertising cases in which the advertising directly targeted the plaintiff’s product.  While the Court acknowledged that this was “not the typical comparative advertising case” because Gnosis did not directly target Merck by mentioning Metafolin in its advertising, the Second Circuit explained that the folate market consisted of only two direct competitors, Merck and Gnosis.  Because Merck was the only competitor to Gnosis, it logically followed that the false advertising campaign conducted by Gnosis injured Merck.  The Court emphasized that in light of this direct competition, that Gnosis’ falsely advertised folate product cost less than Merck’s Metafolin exacerbated the extent of injury to Merck.^[9]

Thus, in the most interesting facet of the Second Circuit’s decision, it held that when “a plaintiff has met its burden of proving deliberate deception in the context of a two-player market, it is appropriate to utilize a presumption of injury.”^[10]  It explained that the application of a presumption of injury was appropriate even if the challenged advertisement “is not a classic instance of comparative advertising where one company’s advertisement mentions a competitor’s product by name.”  Looking at this case, the Second Circuit noted that “the utilization of a presumption of injury” carries no risk of speculative injury to Merck.”^[11]

Damages

The Second Circuit upheld the district court’s award of lost profits, noting that the record supported the finding of willful deception, and that the award of lost profits was necessary to deter future unlawful conduct, prevent Gnosis’s unjust enrichment, and compensate Merck for the business it lost as a result of the false advertising that led certain customers to believe they were purchasing a pure isomer product from Gnosis.  Further, the Second Circuit explained that in a false advertising case such as this one, where the parties are direct competitors in a two-player market, and where literal falsity and willful, deliberate deception have been proved, the presumptions of injury and consumer confusion may be used for the purposes of awarding both injunctive relief and monetary damages to a successful plaintiff.^[12]

Gnosis challenged the district court’s order of corrective advertising arguing that, when coupled with the award of damages, it constituted double recovery.  The Second Circuit disagreed explaining that “in a false-advertising case such as this one, actual damages under section 35(a) can include”:

• profits lost by the plaintiff on sales actually diverted to the false advertiser;

• profits lost by the plaintiff on sales made at prices reduced as a demonstrated result of the false advertising; —the costs of any completed advertising that actually and reasonably responds to the defendant’s offending ads; and

• quantifiable harm to the plaintiff’s good will, to the extent that completed corrective advertising has not repaired that harm.^[13]

Significance of Merck Eprova

In Merck Eprova, the Second Circuit clarified that Lanham Act plaintiffs are afforded a presumption of injury in cases where the plaintiff has met its burden of proving deliberate deception in the context of a two-player market, even if the defendant’s advertising does not mention the competitor’s product by name. Prior to this decision, the presumption was only afforded to plaintiffs in comparative advertisement cases, and plaintiffs in misleading, non-comparative commercials clearly targeting a particular competitor, regardless of whether they explicitly name the competitor.

The Court also expanded the use of presumptions of injury and confusion in the context of awarding damages. Previously these presumptions were only explicitly allowed to be used to award injunctive relief. With this decision, the Court has authorized, in appropriate circumstances, the award of monetary damages on the basis of these presumptions as well.

_{^[1] Merck Eprova AG v. Gnosis S.p.A., 2014 WL 3715078  (2d Cir. July 29, 2014)(“Merck Eprova”).}

_{^[2] The successor to Merck Eprova AG.}

_{^[3] 15 U.S.C. § 1125(a).}

_{^[4] Merck Eprova, 2014 WL 3715078 at *6 .}

_{^[5] PPX Enterprises, Inc. v. Audiofidelity Enterprises, Inc., 818 F.2d 266, 273 (2d Cir. 1987) abrogated on other grounds, as recognized in Hannex Corp. v. GMI, Inc., 140 F.3d 194, 206 n. 9 (2d Cir. 1998); see also id. (“Audiofidelity’s products were patently fraudulent, and the advertising accompanying those products was the vehicle employed to perpetrate the fraud.”).}

_{^[6] See Time Warner Cable, Inc. v. DirecTV, 497 F.3d 144, 153 (2d Cir. 2007) (“When an advertisement is shown to be literally or facially false, consumer deception is presumed, and ‘the court may grant relief without reference to the advertisement’s [actual] impact on the buying public.’”)(quoting Coca Cola Co. v. Tropicana Prods., Inc., 690 F.2d 312, 317 (2d Cir. 1982) (alteration in original)).}

_{^[7] The Second Circuit explained that in light of the finding of literal falsity, it did not need to decide whether the district court’s failure to squarely address Gnosis’s rebuttal evidence, with respect to the literally true, but impliedly false statements warrants remand.}

_{^[8] Merck Eprova, 2014 WL 3715078 at *9 (quoting McNeilab, Inc. v. American Home Prods. Corp., 848 F.2d 34, 28 (2d Cir. 1988)).}

_{^[9] Id.at *10.}

_{^[10] Id. at *11.}

_^[11] Id.

_{^[12] Id. at *12.}

_{^[13] Id. at *15;  see also ALPO Petfood, Inc. v. Ralston Purina Co.,913 F.2d 958, 969 (D.C. Cir. 1990) (internal citations omitted); see also id. at 971 (“In addition to awarding monetary relief, the district court enjoined both parties to prepare, secure court approval of, and disseminate corrective releases, and it enjoined both parties from renewing their false advertising.”).}