Nutritional Ingredient Manufacturer Held Liable for False Advertising

This posting was written by William Zale, Editor of CCH Advertising Law Guide.

Gnosis, a manufacturer of raw ingredients for nutritional companies, falsely advertised its Extrafolate product in violation of the Lanham Act by using the chemical name, abbreviation, chemical formula, and Chemical Abstracts Services registry number reserved for Merck Eprova’s purer folate ingredients, the federal district court in New York City has ruled.

Merck was entitled to an enhanced award of Gnosis’s profits, a permanent injunction including provisions for corrective advertising, and an award of attorney’s fees. The court held that Merck lacked standing under the New York deceptive practices and false advertising laws.

Folate is the B vitamin that helps the body make new healthy cells. All living beings require folates, and they are particularly useful to promote prenatal health for expectant mothers and their fetuses and to lessen the risks of some cancers and cardiovascular diseases.

Gnosis’s folate product was a mixture of the “active” S-isomer and the “inactive “R-isomer. Although Gnosis’s product was admittedly a mixture of these two isomers, Gnosis used terms and the chemical formula for the pure S-isomer product in describing its product.

Merck had standing to sue under the Lanham Act because it was injured when its competitor falsely advertised its chemically distinct product as identical to Merck’s product. In an organized advertising campaign Gnosis widely distributed materials that were literally false and that materially misrepresented the nature of what Gnosis was selling, the court determined. Gnosis also distributed brochures with literally true descriptions of a pure 6S Isomer Product that were impliedly false and intended to mislead customers in connection with Extrafolate, which was not a pure 6S isomer, the court found.

Gnosis was liable, not only for direct false advertising, but also for contributory false advertising because its false use of the common chemical name caused its distributors to advertise falsely, the court decided.

Enhanced Profits Award

The award of Gnosis’s profits was held necessary to prevent it from falsely advertising in the future. Gnosis’s conduct during its advertising campaign and litigation revealed its disdain for the law and the court. It deliberately and willfully engaged in false advertising as part of a strategy designed to gain its market share in the lucrative vitamin and nutritional supplement industry through deception, according to the court.

Though the plain language of the Lanham Act permits trebling of only of damages, an award of profits may be enhanced without identified limit to “such sum as the court shall find to be just if “the amount of the recovery based on profits is . . . inadequate, under 15 U.S.C. § 1117(a). Gnosis’s profits during the applicable period were $175,664.71. This amount was increased to $526,994.13 in order to compensate Merck for the improved market position Gnosis enjoyed solely as a result of its false advertising, the court found.

Injunctive Relief

Injunctive relief was appropriate because Merck suffered irreparable harm and the damages award, based only on sales up to March 2009, did not fully compensate Merck. Gnosis was to be (1) permanently enjoined from advertising its 6R,S Mixture Product with the names 6S-5-methyltetrahydrofolate, L-5 methyltetrahydrofolate, L-S-MTHF, or any synonyms thereof and (2) ordered to engage in a campaign of corrective advertising to be approved by the court with input from Merck.

Attorney’s Fees

An award of attorney’s fees was appropriate. Gnosis’s false advertising was willful and done in bad faith and because its litigation strategy was conducted in bad faith with senior officers, including its CEO, frustrating the litigation process at every turn, the court found.

New York Law

Merck lacked standing under the New York deceptive practices and false advertising laws. Corporate competitors have standing under the New York law if the gravamen of the complaint is consumer injury or harm to the public interest. Although Merck’s experts posited that there may be some negative health consequences associated with the R-isomer, Merck had not definitively established that these negative health consequences were also associated with the Gnosis’s 6R,S mixture product, the court determined. Instead, Merck’s allegations focused almost entirely on losses suffered by Merck itself, not the eventual—and theoretical— harm suffered by the public at large.

The opinion in Merck Eprova AG v. Gnosis S.p.A. will be reported at CCH Advertising Law Guide ¶64,835.

Wrongful Termination: "Community of Interest" Under the Wisconsin Fair Dealership Law

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

A conflict seems to have developed between the federal courts' interpretation of the Wisconsin Fair Dealership Law and that of the Wisconsin courts. The Seventh Circuit in Home Protective Services, Inc. v. ADT Security Services, Inc., CCH Business Franchise Guide ¶13,266, affirmed a district court ruling finding no "community of interest" for a plaintiff that derived 95 percent of its revenue from the defendant and devoted 95 percent of its personnel hours to its arrangement with the defendant.

This decision was recently followed by the federal district court in Milwaukee. Stucchi USA, Inc. v. Hyquip, Inc. (E.D. Wis. July 28, 2010), CCH Business Franchise Guide ¶14,437.

However, the Wisconsin Court of Appeals, in the case of Water Quality Store, LLC v. Dynasty Spas, Inc., CCH Business Franchise Guide ¶14,426, held that the federal construction of Wisconsin statutes need not be followed by Wisconsin courts, citing particularly the Home Protective Services v ADT case.

It referenced a subsequent decision by the Wisconsin Supreme Court, Central Corp. v Research Products Corp., CCH Business Franchise Guide ¶13,560, which resurrected earlier case law, Ziegler Co., Inc. v. Rexnord, Inc.(Wis. S. Ct. 1983), CCH Business Franchise Guide ¶8882.

The Wisconsin Court of Appeals found there was a "community of interest" between a spa distributor and manufacturer, even though the manufacturer did not require an investment and even though the distributor was immediately able to find a replacement brand of spas to distribute --though not at the same volume.

Franchisor Could Be Liable Under Workers' Compensation Act

In an unusual situation, a Kentucky appellate court found that a franchisor of sandwich shops could be liable for the payment of workers' compensation benefits for an injured employee of a franchisee under the Kentucky Workers' Compensation Act because the nature of the relationship between the franchisor and the franchise could have constituted "remuneration" under the Act, and the franchisee could fit the Act's definition of a "subcontractor." Uninsured Employers' Fund v. Brown (Ky. Ct. App. September 3, 2010), CCH Business Franchise Guide ¶14,453.

Thus, the court reversed decisions of an administrative law judge and the Kentucky Board of Workers' Claims. Classification as a subcontractor is usually desired by franchisors, but in this case, it may have backfired.

Discovery Limited for Experts' Reports and Communications

Federal Rules of Civil Procedure 26 (3) (A) and (B), relating to experts' draft reports and expert-attorney communications, have been changed, effective December 1, 2010. This means such documents will no longer be discoverable except for:

(1) Those that relate to the expert's compensation;
(2) Facts and data provided by counsel that the expert considered; and
(3) Assumptions provided by counsel that the expert considered.

(Report of the Judicial Conference Committee on Rules of Practice and Procedure to the Chief Justice of the United States and Members of the Judicial Conference of the United States.)

Constructive Trust Imposed on Defense Counsel's Fees

In a cautionary tale for franchise attorneys who represent clients that walk on the wild side, the Federal Trade Commission's imposition of a constructive trust on attorneys' fees paid to defense counsel who should have known their clients were crooks was upheld by the U.S. Court of Appeals in San Francisco. Federal Trade Commission v. Network Services Depot, Inc., CCH Business Franchise Guide ¶14,447.

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Additional information on the issues discussed above is available in CCH Franchise Regulation and Damages by Byron E. Fox and Bruce S. Schaeffer.