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Using U.S. Intellectual Property Rights to Prevent Parallel Imports
By Lynda J. Zadra-Symes and Joseph J. Basista
May 1998

Quality King Distributors v. L’anza Research International, Inc.

Grey market goods, also known as parallel imports, are goods produced by a United States manufacturer and exported to a foreign distributor for sale at reduced prices in a foreign country. These goods are often re-imported back into the United States and compete with goods distributed through authorized U.S. distributors, often forcing these authorized distributes to lower their prices. Because U.S. manufacturers do not like competing against themselves, they try to prevent re-importation of these goods by various means. One attempt to halt such parallel imports has been to copyright the labels on exported products, and then claim that re-importation of these copyrighted labels into the U.S. is an infringement of the U.S. copyright. The U.S. Supreme Court’s recent decision in Quality King Distributors v. L’anza Research International, Inc., essentially shattered such attempts to use the U.S. Copyright law to halt parallel importation of genuine goods. However, as this Comment discusses, U.S. manufacturers will still be able to invoke various provisions of the U.S. Patent, Trademark and Copyright Laws, in limited circumstances, to stem the flow of parallel imports.

The Facts

Imagine two bottles of hair shampoo sitting on a store shelf somewhere in the United States. These bottles are virtually identical; they have the same label, the same ingredients, they cost the same to make and were even manufactured in the same U.S. factory.

The first bottle was sold by the U.S. manufacturer to an American distributor for sale in the United States. The second bottle, however, was sold by the same manufacturer to a foreign distributor for sale outside the United States only. This second bottle was then resold by the foreign distributor to a third party who reimported the bottle into the United States. A consumer purchasing either of these bottles could not tell them apart, except for one major difference: the second bottle costs much less than the first.

This is the reality of the trade in "parallel imports," also known as "grey market goods." When U.S. manufacturers sell their goods to foreign distributors, the price charged to these foreign distributors is often significantly lower than that charged to U.S. distributors. In many situations, this price differential is so significant that a third-party importer can purchase the goods from the foreign distributor, import the goods back into the United States and sell them at a tidy profit, while still undercutting the authorized U.S. distributor’s prices for the same branded goods.

Of course, U.S. manufacturers and their distributors do not like competing with their own products, and seek to halt the flow of grey market goods into the United States whenever possible. While such manufacturers typically incorporate geographic restrictions into their distribution contracts and/or license agreements, it is often difficult to determine which party in a chain of distribution had notice of and violated such restrictions, making enforcement of these contractual provisions time-consuming, expensive and a chancy proposition at best. Because of this, U.S. companies frequently turn to the U.S. patent, trademark and/or copyright laws to halt such importation, with varying degrees of success.

The U.S. Supreme Court’s recent decision in Quality King Distributors v. L’anza Research International, Inc., has severely curtailed U.S. manufacturers’ use of the U.S. copyright law to prevent parallel importation into the United States for genuine goods manufactured in the United States for export. This comment discusses the various ways in which U.S. intellectual property rights have been invoked to prevent parallel imports into the United States, the Supreme Court’s recent decision in Quality King, and the likely response to that decision.

Patent Enforcement to Prevent Grey Market Imports

Traditionally, a patentee’s first sale of a patented article "exhausts" all the patentee’s rights to control further the disposition of that article. The basic rule is that once a patentee sells his patented article, the article is "set free from his monopoly by his own act, consent and permission." In fact, when a patent owner sells a patented article, that sale is presumed to free the article from the monopoly of any patents that the vendor possesses. Although most commonly associated with domestic sales of patented articles, this "first sale defense" applies equally to foreign sales of a patented article.

However, the patent owner is free to place various restrictions on the license and/or sale of a patented article, within certain limits prescribed by the antitrust laws. A geographic restriction prohibiting subsequent importation in the United States is not considered patent misuse or a per se violation of the antitrust laws. Of course, such a restriction must be expressly stated at the time of sale or license, or it will be presumed that the patentee intended to part with all of his rights in the article. Where such an express restriction exists, however, a purchaser of the goods who imports these goods into the United States can be sued by the U.S. patent owner for infringement of the U.S. patent.

Obviously, patent protection to prevent parallel importation may only be invoked where the product can be protected under a U.S. patent and where geographic restrictions on re-importation have been expressly (and legally) incorporated into the license and/or sales agreement. For the vast majority of "grey market" products, therefore, patent laws if of little use in the fight against parallel importation.

Trademark Enforcement to Prevent Grey Market Imports

Trademark enforcement to prevent parallel imports may be asserted under three different statutes: The Tariff Act § 526, the Lanham Act § 42, and §§ 32(a) for registered marks and 43(b) for unregistered marks.

The Tariff Act

The Tariff Act § 526(a) prohibits absolutely the importation of a product of foreign manufacture "that bears a trademark owned by a citizen of … the United States and is registered in the U.S. Patent and Trademark Office." Section 526(a) is the only means by which a U.S. company can use its U.S. trademark to prevent importation of truly genuine goods manufactured abroad. It requires no proof of a likelihood of confusion, but is exclusively available for domestic U.S. trademark owners that have no corporate affiliation with the foreign manufacturer.

The Lanham Act

Section 32(a) of the U.S. trademark statute, the Lanham Act, provides the general remedy for trademark infringement and proscribes the use in commerce of any reproduction, counterfeit, copy or colorable imitation of a registered trademark which is likely to cause confusion. Section 42 bars the importation of goods bearing a mark which shall "copy or simulate" a registered trademark, enabling the registered owner of a trademark to have counterfeit products seized by Customs at the border. However, the plain language of Section 42 does not bar importation if the goods are genuine, only if they copy or simulate a trademark. From a trademark infringement perspective, the question arises that if grey market goods are in fact genuine, how does their sale in the United States deceive consumers as to source?

The leading decision on invoking the Lanham Act against grey market goods is the U.S. Supreme Court’s decision in A. Bourjois & Company v. Katzel. In Katzel, a U.S. company, Bourjois, purchased all the U.S. business, goodwill and rights to the U.S. trademark in "Java" face powder from the French manufacturer. Bourjois was completely independent of the French company. A competitor of Bourjois purchased the face powder abroad, imported it into the United States and marketed it under the same trademark in competition with Bourjois.

The Supreme Court held that the importation of the competing grey market goods infringe Bourjois’ trademark rights because the U.S. public understood that the trademark in the United States signified that the goods came from the plaintiff, not the French company. Therefore, the importation and sale of even genuine goods by anyone else would be likely to cause confusion as to source. The defendant’s use of the trademark misrepresented the origin of the goods in the United States and therefore constituted trademark infringement.

The Court also noted that the French manufacturer would violate its assignment agreement if it marketed the product in the United States and should not be able to usurp that agreement by selling outside the United States to Bourjois’ competitor.

Subsequent courts have limited Katzel to its specific facts, and generally do not allow U.S. trademark owners to invoke the Lanham Act to prevent importation of genuine goods bearing the same trademark.

No Prohibition on Imports Where Common Ownership Exists Between U.S. Trademark Holder and Foreign Service

The U.S. courts have also developed an exception to Katzel where there is a parent-subsidiary relationship between the U.S. trademark holder and the foreign manufacturer. The rationale generally relied on for this exception is that the trademark owner, as part of the corporate entity, has already benefited from the profits it received from the foreign sales, and should not be able to use the U.S. trademark laws to set up discriminatory pricing schemes which prejudice U.S. consumers.

In Weil Ceramics and Glass, Inc. v. Dash, the Third Circuit distinguished Katzel and extended the Supreme Court’s interpretation of the Tariff Act in K-Mart Corp. v. Cartier, Inc. to deny trademark protection as a means of preventing parallel imports. Weil, the plaintiff trademark holder, was the wholly owned subsidiary and exclusive U.S. distributor of Lladro, a Spanish company. The defendant purchased Lladro porcelain from the Spanish manufacturer and imported it into the United States without Weil’s permission. The Third Circuit denied trademark protection to prevent the importation because of the common ownership between Weil and the Spanish manufacturer:

Weil is not independent of the foreign manufacturer … Thus, even if Weil loses some share of its United States market to Dash, it nonetheless benefits from the profits it received as part of the corporate entity from which the defendant purchased the goods abroad … the Lanham Act … does not protect a foreign manufacturer — that either owns or is owned by a domestic trademark holder — from compensation … in the United States by a domestic importer that it has supplied.

Similarly, in NEC Electronics v. CAL Circuit Abco, the Ninth Circuit focused on the corporate affiliation between the U.S. trademark holder and the Japanese manufacturer to deny Lanham Act protection to NEC—USA:

"If NEC-Japan chooses to sell abroad at lower prices than those it would obtain for the identical products here, that is its business. In doing so, however, it cannot look to United States trademark law to insulate the American market or to vitiate the effects of international trade. This country’s trademark law does not offer NEC-Japan a vehicle for establishing a worldwide discriminatory pricing scheme simply through the expedient of setting up an American subsidiary with nominal title to its mark."

Thus there is no Lanham Act or Tariff Act violation when there is importation into the United States of genuine trade marked goods sold abroad by the patent or subsidiary of the U.S. trademark holder.

Non-genuine Grey Market Imports: Material Differences Between Imported and U.S. Goods

Even in the case of common ownership between the U.S. trademark owner and the foreign source, U.S. trademarks may be relied on to prevent parallel importation where there is a "material difference" between the U.S. trademarked goods and the imported goods bearing the same mark.

Where such material differences exist, many U.S. courts have found that the imported goods are not genuine, and that use of the U.S. trademark on the imported goods causes a likelihood of customer confusion, thereby constituting trademark infringement. The confusion arises because U.S. consumer expectations are not being met and the U.S. trademark owner’s goodwill is diminished by an association with goods of a "lesser" quality.

For example, in Original Appalachian Artworks, Inc. v. Granada Electronics, Inc.,, the court found that foreign made "Cabbage Patch Kids" dolls were materially different from their U.S. counterparts because the "adoption papers" and "birth certificates" for the dolls were in Spanish and were not accepted by the U.S. "adoption" system. Because the adoption process was critical to consumers, this difference would be considered "material," and thus importation of the dolls would constitute infringement of the trademark. Another example of a "material difference" occurred in Dial Corp. v. Manghnani Inv. Corp., in which the court found that the differences between the formulation, fragrance and size of "Dial" soap sold in the United States were material. Because U.S. consumers would be likely to confuse the U.K. soap for U.S. soap, the court held that importation of the U.K. "Dial" soap would constitute trademark infringement.

Other examples of "material differences" found by U.S. courts to justify preventing grey market imports include the following:

        — tractors having Japanese-language warning labels or no labels at time of importation were materially different from authorized U.S. tractors bearing English-language warning labels

        — figurines incorporated designs, painted patterns and colors which were different from authorized U.S. figurines;

        — differences in product labeling (no list of ingredients and no product weight on grey market product) and product composition between Canadian hair products and authorized U.S. products constituted material differences;

        — obliteration of "batch codes" on surface of bottle by grey marketeer, which left noticeable scars on bottle surface and occasionally erased other information, constituted material difference;

        — difference in size of valve stem hole on mountain bike wheel rim constituted material difference (grey market import had 8.5 mm "Schrader" valve hole while authorized U.S. product had 6.5 mm "Presta" valve hole);

        — differences in quality control, composition, configuration, and price between authorized Italian imported "Perugina" chocolates and grey market "Perugina" chocolates imported from Venezuela without the authorization of the U.S. distributor;

        — differences in caloric content and size of U.K. "Tic Tac" mints from authorized mints distributed in the United States;

        — differences in smell, lather content and antibacterial content between U.K. "Shield" soap and U.S. "Shield" soap;

        — foreign language packaging and instructions, disparities in warranty protection, and quality differences between grey market product and authorized U.S. product (life of imported batteries was shorter because of delays in shipment to United States);

        — differences between grey market product and authorized Puerto Rican product included volume content of "Pepsi" cans (10 oz. versus 11.27 oz.) and greater risk of leakage and carbonation in grey market product due to shipment hazards.

        In these cases, the courts do not judge whether the grey market product is inferior to the authorized U.S. product. Rather, the courts focus on whether the grey market product is "different," such that a consumer purchasing the grey market product would find something unexpected, resulting in "consumer confusion." If, however, the authorized imports and the parallel imports are not "materially different," the confusion rationale does not apply and the Lanham Act does not bar the parallel imports.

Copyright Enforcement to Prevent Parallel Imports

Frustrated with the impotence of the U.S. trademark statute to prevent importation of genuine goods having no "material differences," and the parent-subsidiary limitations in the Lanham and Tariff Acts, many U.S. companies turned to their copyrights as a means of preventing such imports, and routinely registered U.S. copyrights in the packaging for their products sold overseas.

As a result, there has been a flurry of recent cases relating to the use of U.S. copyrights to prevent parallel imports. Most of these cases have focused on whether the "first sale" doctrine encompassed in Section 109 (a) of the copyright statute provides a defense to the importation prohibition in Section 602(a).

The First Sale Doctrine

The first sale doctrine in Section 109 (a) is based on the theory that once the copyright owner sells or authorizes the sale of a copyrighted article, "it may fairly be said that the copyright proprietor has received his reward for its use." In effect, once a copyright holder chooses to part with its work, this doctrine prohibits the owner from further control over the work. While the first sale doctrine has been held to apply to sales made within the United States, its application to foreign sales was rather unclear, and led to the split between the Ninth and Third Circuit Courts of Appeals.

Foreign-Manufactured Grey Mark Goods

The Ninth Circuit Court of Appeals has routinely dismissed the application of the first sale doctrine to grey market goods first manufactured and sold abroad, thus allowing the owner of the U.S. copyright to prevent importation of grey market goods under Section 602(a).

For example, in BMG Music v. Perez, the Ninth Circuit held (relying on Columbia Broadcasting System, Inc. v. Scorpio Music Distributors, Inc.) that the first sale doctrine would not provide a defense to infringement by importation under Section 602(a), where the copies in question were manufactured outside the United States, because the words "lawfully made under this title" in Section 109(a) meant "legally manufactured and sold within the United States." The Ninth Circuit also denied application of the first sale doctrine as a restriction on Section 602(a) in Parfums Givenchy v. Drug Emporium and Parfums Givenchy v. C & C Beauty Sales, discussed below.

In Parfums Givenchy v. Drug Emporium, the plaintiff owned the U.S. copyright to the box design for "Amarige" perfume which was manufactured in France. Drug Emporium was selling the perfume in the copyright box in the United States without the authorization of Givenchy USA. Drug Emporium had purchased the perfume in the United States from third parties who lawfully purchased it from Givenchy France and imported it into the United States without the authorization of Givenchy USA. The Ninth Circuit denied Drug Emporium’s request to apply the first sale doctrine in Section 109(a) as a defense to the importation prohibition in Section 602(a), reasoning that Section 602(a) was enacted to provide greater remedies for U.S. copyright owners and to make the mere act of importation, regardless of sale, an infringement of the distribution right in Section 106(3).

The Ninth Circuit also rejected the argument that Givenchy USA, the U.S. copyright owner, was the wholly owned subsidiary of the foreign manufacturer, Givenchy France and, therefore (by analogy with the Trademark Law and Tariff Act), should not be allowed to prevent the grey market imports. According to the Ninth Circuit, the rationale behind the Tariff and Lanham Acts in protecting domestic interests was not applicable to the Copyright Act, and there was nothing in Section 602(a) or its legislative history to suggest that U.S. subsidiaries of foreign manufacturers should be treated any differently from other U.S. copyright holders.

In Givenchy v. C & C Beauty Sales, the Ninth Circuit again agreed with BMG Music in its observation that construing Section 109(a) as superseding Section 602 (a) would render meaningless the importation prohibition in Section 602(a). The court did not, however, agree with BMG Music’s and Scorpio’s, interpretation of "lawfully made under this title" in Section 109(a). Rather, the court held that unauthorized importation of copyrighted goods prevents the U.S. copyright owner from realizing the full value of each copy released into the U.S. market with his authorization (this reasoning was also reflected in the Ninth Circuit’s Drug Emporium opinion).

The Ninth Circuit’s refusal to apply the first sale doctrine to goods manufactured and sold abroad resulted in an interesting situation. Foreign manufacturers who hold U.S. copyrights could benefit from the importation prohibition in Section 602(a) to restrict importation of goods which they themselves manufactured and/or sold abroad, thereby obtaining greater copyright protection than a U.S. manufacturer which manufactured or sold goods in the United States and is subject to the first sale doctrine in Section 109(a); see Red Baron-Franklin Park Inc. v. Taito Corp.

Grey Market Goods Manufactured in the United States and Exported

The Ninth Circuit’s interpretation of Section 602(a) in L’anza Research Int’l. v. Quality King Distributors was seen by many as fresh ammunition in the war against parallel imports of goods first manufactured in the United States.

The plaintiff, L’anza, a U.S. manufacturer of hair care products, obtained U.S. copyright registrations for the labels attached to its products. In 1992 and 1993, L’anza exported its products directly to a U.K. distributor at prices 30 to 40 percent below the prices charged to U.S. distributors. The U.K. distributor resold these products to a third party who then imported them into the United States. These products were eventually purchased by the defendant, Quality King, a discount wholesaler, for sale in the United States.

L’anza sued Quality King in the Central District of California for copyright infringement under the importation prohibition in 17 U.S.C. § 602(a). There was no dispute that the goods were genuine, manufactured and first sold by L’anza itself. Nor was there any allegation that the products and/or their labels had been improperly copied, altered, or adulterated in any way. In defense, Quality King claimed that, because L’anza itself manufactured and introduced the copyrighted work into the stream of commerce, the "first sale" doctrine in 17 U.S.C. § 109(a), should prevent L’anza from controlling later disposition of the copyrighted work.

The District Court held that the first sale defense did not apply to Section 602(a), relying on the Ninth Circuit reasoning that the words "lawfully made under this title" in Section 109(a) grant first sale protection only to copies legally made and sold in the United States.

On appeal by Quality King, the Ninth Circuit affirmed the District Court’s decision, but emphasized that its holding did not depend on the words "lawfully made under this title" in Section 109(a). Rather, the Ninth Circuit relied on the alternative ground on which BMG and Drug Emporium were decided, that Section 602(a) would be rendered meaningless if Section 109(a) were found to supersede the prohibition on importation. The Ninth Circuit followed the reasoning of C & C Beauty Sales that the "first sale doctrine presupposes that the copyright owner will be able to realize the full value of each authorized copy … upon its first sale to a purchaser." Importation of copies from outside the United States resulted in copyright owners being deprived of the "full value" to which they were entitled for copies sold within the United States, even though the imported copies may have been the subject of a valid first sale.

The Ninth Circuit’s decision created a direct conflict with a previous Third Circuit decision in Sebastian International, Inc. v. Consumer Contacts (Pty.), Ltd., which the Ninth Circuit and the Central District of California declined to follow. In Sebastian, the Third Circuit held that the first sale anywhere by the copyright owner extinguishes any right later to control importation of those goods. The plaintiff, Sebastian, printed copyrighted labels in the United States and exported them overseas. The defendant reimported goods bearing the copyrighted labels. The Third Circuit emphasized that Sebastian produced and sold the same labels which it sought to control under Section 602(a), and found for the defendant, holding that the first sale defense in Section 109(a) applied. The Third Circuit expressly criticized the holding of CBS v. Scorpio restricting the application of Section 109(a) to goods manufactured and sold in the United States. Because of this direct conflict between the Ninth and Tenth Circuit, the U.S. Supreme Court granted certiorari to hear Quality King’s appeal from the Ninth Circuit’s decision.

The Issues Facing the U.S. Supreme Court in Quality King v. L’anza Research International

The authority for the U.S. Copyright Statute stems from Article I, section 8, clause 8 of the U.S. Constitution, which states that "The Congress shall have power … to promote the progress of science and useful arts, by securing for limited time to authors and inventors the exclusive right to their respective writings and discoveries."

Fulfillment of this goal requires careful balancing of two competing interests: (1) the "incentive" or "reward" granted to the copyright owner in exchange for disclosure of the work, versus (2) making the copyrighted work freely available to the public. In deciding whether the first sale doctrine embodied in Section 109(a) applied as a defense to Section 602(a), the Supreme Court had to strike a balance between these competing interests.

Quality King very persuasively argued that the policies underlying the copyright statute would not support the Ninth Circuit’s interpretation of the statute entitling the U.S. copyright holder to obtain "the full value" of the copyrighted work in the United States, irrespective of a first sale abroad. In support, Quality King quoted the Supreme Court’s own language from Sony Corporation of America v. Universal City Studios, Inc.: "The Copyright law, like the patent statutes, makes reward to the owner a secondary consideration."

Quality King also questioned the use of the copyright laws to impose significant restrictions on free trade and commerce, asking whether such restrictions should be implemented as a matter of copyright "policy," or should rather be implemented only by the expressed will of Congress through legislation.

Quality King’s "policy" arguments cut to the heart of this case. If the U.S. Trademark and Customs laws would not prevent gray market importation of genuine goods on the facts of this case, why should the copyright law do any better? According to Quality King, "[T]o allow L’anza to use those labels to further a private commercial strategy of maintaining inflated prices in this country would subvert the true purposes of the Copyright Act." The Supreme Court agreed, noting L’anza’s true intent in invoking the Copyright Act:

"This is an unusual copyright case because L’anza does not claim that anyone has made unauthorized copies of its copyrighted labels. Instead, L’anza is primarily interested in protecting the integrity of its method of marketing the products to which the labels are affixed."

L’anza argued that Section 602(a) creates a right which is distinct from the exclusive distribution right in Section 106(3), and thus is not subject to Section 109(a). Otherwise, L’anza argued, Section 602(a), and particularly its exceptions, are superfluous if limited by the first sale doctrine in Section 109(a). L’anza also argued that the text of Section 501 defining an "infringer" refers separately to violations of Section 106, on the one hand, and to imports in violation of Section 602 on the other hand.

The Court rejected these arguments because neither of them adequately explained why the words "under Section 106" appear in Section 602(a). The Court found it significant that Section 602(a) does not categorically prohibit the unauthorized importation of copyrighted materials, but only provides that such importation is an infringement of the exclusive right to distribute copies "under Section 106, actionable under Section 501." The introductory language in Section 106 expressly states that all the exclusive rights granted by that section (including the distribution right in subsection (3)) are limited by the provisions of Sections 107 to 120. One of those limitations is Section 109(a), which expressly permits the owner of a lawfully made copy to sell that copy "[n]otwithstanding the provisions of Section 106(3)."

If Section 602(a) functioned independently, reasoned the Supreme Court, none of Section 107 to 120 would limit its coverage. Even the "fair use" defense embodied in Section 107 would be unavailable to importers if Section 602(a) created a separate right not subject to the limitations on Section 106. Under this interpretation, it would be unlawful for a distributor to import copies of a British newspaper that contained a book review quoting excerpts from an American novel protected by a U.S. copyright. The Supreme Court did not believe that Congress intended to impose such an absolute ban on the importation of all such works containing any material protected by a U.S. copyright. Indeed, in construing the Copyright Act, the court stated:

"we must remember that [the Act’s] principal purpose was to promote the progress of the "useful arts," U.S. Const., Art. I, § 8, cl. 8, by rewarding creativity, and its principal function is the protection of original works, rather than ordinary commercial products that use copyrighted material as a marketing aid."

The Court also pointed out that Section 602(a) provides broader coverage than Section 109(a), and thus applying Section 109(a) as a first sale defense to Section 602(a) could not render portions of Section 602(a) superfluous. Section 109(a) applies only to copies "lawfully made under this title," i.e., under the U.S. Copyright Act. Section 602(a) on the other hand, was intended to apply to all copies, whether made lawfully under U.S. law or the law of some other country. Because Section 602(a) provides broader coverage (it encompasses copies that are not subject to the first sale doctrine, e.g., copies that are lawfully made under the law of another country), allowing Section 109(a) to provide a defense to Section 602(a) would not render portions of Section 602(a) superfluous.

Finally, the Court found irrelevant to its interpretation of Section 602(a) the fact that the Executive Branch of the Government had entered into five international trade agreements apparently intended to protect domestic copyright owners from the unauthorized importation of copies of their works sold in those five countries.

The Future

The Supreme Court decision in Quality King has essentially shattered any further attempts to use the U.S. copyright law to halt parallel importation of genuine goods originally manufactured in the United States and exported. Because the court’s decision only addressed parallel importation of goods manufactured in the United States, however, U.S. manufacturers may still be able to invoke the importation prohibition in Section 602(a) if they transfer production to a foreign affiliate. Interestingly, this may put foreign manufacturers who hold U.S. copyrights in a better position than U.S. manufacturers. However, U.S. manufacturers may still draw some solace from the "material differences" line of cases under the U.S. trademark statute. By sufficiently changing the labeling, warranties and/or content of their foreign-distributed goods to be country specific, they will be able to argue that the parallel imports are not genuine goods and are likely to cause customer confusion if allowed to penetrate the U.S. market.

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