One little-publicized part of the new tax law (Tax Cuts and Jobs Act of 2017) may negatively affect the value of some patents and other intellectual property.  It does so by changing the tax treatment of income from sales of “patents, models and secret formulas or processes” from capital gains to ordinary income.

Prior to the amendment of Tax Code Section 1221(a)(3), income from sales of (1) “patents, models and secret formulas or processes,” (2) held by the IP creator, (3) for more than one year, was taxed at the capital gains rate.  This resulted in lower tax than the ordinary income tax rate that applied to other types of IP, such as copyrights, literary, musical, and artistic compositions.  Congress has now taken this tax advantage away.

The change in the law affects those that sell or license IP in the “primary market” only —in other words, the original creators of the IP.  It generally does not affect those that have paid to own the IP, including the IP creators’ employers.

There still remains an exception under Tax Code Section 1235 providing for lower tax on sales and licensing of all rights to patents, secret formulas and trade names (but only these types of IP).  For other types of IP, adjustments in sale prices and license royalties will need to compensate for the higher tax under the new law.

Our tax and IP groups can help you assess the new law’s impact on these valuable assets.

The First Amendment and Trademarks: Protecting “The Thought We Hate”

Can the federal government refuse to register offensive trademarks?  The Supreme Court held yesterday that it cannot.  Although the case did not directly involve the “Washington Redskins” trademark registration, discussed in previous blog articles in this space, it effectively gave the Redskins a victory in their effort to reinstate their trademark registration against efforts to cancel their mark as disparaging.

The Lanham Act governs all federal registration of trademarks.  Since it was enacted in 1946, the Lanham Act has included the “Disparagement Clause,” which prohibits the registration of trademarks “which may disparage . . . persons, living or dead, institutions, beliefs or national symbols, or bring them into contempt, or disrepute.”  In Matal v. Tam, No. 15-1293 (2017), a case sure to have wide-ranging effects, the Supreme Court unanimously held the Disparagement Clause unconstitutional under the First Amendment.

The case involves Simon Tam, the lead singer of a band called “The Slants,” who sought federal registration of “THE SLANTS” trademark.  The band chose its name in an attempt to “reclaim” and “take ownership” of stereotypes about its members’ own Asian ethnicities.  The United States Patent & Trademark Office (“PTO”) rejected Tam’s request to register the mark under the Disparagement Clause, finding “there is . . . a substantial composite of persons who find the term in the applied-for mark offensive.”

The Supreme Court, however, held the rejection of Tam’s registration unconstitutionally discriminated against speech.  The Supreme Court resolved two key issues.  First, it found that trademarks are private speech; not government speech.  Second, the Court ruled that such viewpoint-based discrimination of trademarks is impermissible.

Trademarks are Private, Not Government, Speech

The First Amendment does not regulate government speech.  The general effect of this principle is that the government is not required to give equal time and representation to competing viewpoints when the government itself speaks – in contrast to government regulation of a private person’s speech, which must be viewpoint-neutral.  For example, the government is not required to mount a pro-smoking crusade to balance out its anti-smoking campaign.  In Tam, the PTO argued that the act of approving of a trademark was itself government speech and therefore was not within the reach of the First Amendment.

Justice Alito, writing on behalf of the entire Court, quickly shot down the PTO’s contention, ruling that trademarks are private, not government, speech.  The Court explained that the government does not “dream up” the marks a private party seeks to register: the PTO registers the mark under the Lanham Act based on objective criteria, regardless of the content of the mark.  If registering a trademark is government speech, the Court wrote, then the government is “babbling prodigiously and incoherently” while “expressing numerous contradictory views . . . [and] unashamedly endorsing a vast array of commercial products and services.”  To hold otherwise would disqualify any speech subject to government registration from First Amendment protection.  This would necessarily include copyright protection, with broad and disturbing implications for the speech expressed in copyright-protected writing, art, music, film, and other content.

The Disparagement Clause Impermissibly Discriminates Based on Viewpoint

Having decided that trademarks are covered by the First Amendment’s free speech protection, the Supreme Court went on to find that the Disparagement Clause embodied an unconstitutional discrimination against speech based on its viewpoint.  Although the Court could not muster a five-member majority to agree on the exact reasoning, the Court unanimously disapproved the refusal to register trademarks based on their perceived offensiveness.

As four members of the Court explained, the Disparagement Clause impermissibly authorized the PTO to “favor some viewpoints or ideas at the expense of others.”  “Giving offense,” they wrote, “is a viewpoint.” Because the PTO’s refusal to register “The Slants” was to prevent offense, it ran afoul of “the heart of the First Amendment,” which protects “the freedom to express ‘the thought that we hate.’”  And because the Disparagement Clause impermissibly went further than necessary to achieve the government’s purported goal of preventing discrimination, it was unconstitutional.  A majority of the Court arguably went further, holding that because the Disparagement Clause impermissibly discriminated based on viewpoint, it was subject either to “heightened” or “strict” scrutiny and was therefore invalid regardless of whether it furthered the prevention of discrimination.

The Effects of Tam

The effects of Tam are likely to be comprehensive and wide-ranging.  In invalidating the Disparagement Clause, the Court ruled the PTO cannot refuse to register a trademark because it is disparaging.  This calls into question whether any viewpoint-based discrimination for a business’s trademarks or copyrights will pass constitutional muster.  Most prominently, it is good news for the embattled Washington Redskins, who were under fire when the PTO previously cancelled their registration based on their mark disparaging Native Americans.

You may know that “aspirin,” the word commonly used to describe acetylsalicylic acid, was once a trademark ­– i.e., brand name – for the acetylsalicylic acid made by one company: Bayer.  The word “aspirin” lost its trademark status because the public came to use the word to mean acetylsalicylic acid made by anyone, not just Bayer.  In trademark-speak, “aspirin” became “generic,” and Bayer’s “aspirin” trademark fell victim to “genericide.”  Other familiar victims of genericide are “cellophane,” “thermos,” and “xerox” (though “xerox” was resurrected through the efforts of the brand owner, Xerox Corporation).

Is “Google” the latest victim of genericide?  Two individuals in a lawsuit in federal court in Arizona claimed it is.  They argued that the public uses “google” as a generic word for the act of searching on the internet (as in, “I googled it”).  They sought to cancel Google’s trademark registration in an effort to defend their registration of hundreds of domain names containing the word “google.”

In Elliott v. Google, No. 15-15809 (9th Cir. May 16, 2017), the Arizona district court rejected the argument that “google” had become generic, and the Ninth Circuit Court of Appeals affirmed.  According to the court, the question is not whether the public sometimes uses “google” generically to refer to an Internet search.  The question is whether the primary significance in the public mind of the word “google” is to identify the act of searching on the Internet or a particular search engine provider.  As long as the primary significance is to identify “who” is providing the service – for example, to distinguish Google from Microsoft (which offers the “Bing” search service) – the mark is safe from genericide. The court held that the plaintiffs had failed to prove that “google” had become generic and rejected the effort to cancel Google’s trademark registration.

Proving genericide is difficult.  This case is a reminder, however, that trademark owners – especially those whose product or services become well-known – should be vigilant to ensure the public understands that their trademarks indicate the “who” that provides product or service rather than the product or service itself.

All too often parties lack the foresight to contractually address potential intellectual property issues.  When those issues bubble over into full-fledged disputes, it often falls to the courts to fill the void in contractual language.  Two primary tests have been used by courts to determine ownership of an unregistered trademark between a manufacturer and distributor where there is no dispositive agreement: the “first use test” and the “McCarthy test” (for the well-known trademark law author).  In Covertech Fabricating, Inc. v. TVM Building Products, Inc., Case No. 15-3893 (3d Cir. Apr. 18, 2017), the Third Circuit joined a number of its sister courts and chose to adopt the McCarthy test.

Covertech involved a dispute where a manufacturer and an exclusive distributor worked in concert to sell the manufacturer’s product from its inception.  The Court held, per McCarthy, under these circumstances there is a rebuttable presumption that the manufacturer of the product owns the mark.  It then falls on the distributor to rebut the presumption using McCarthy’s multi-factor balancing test.

Under the McCarthy test, a court weighs six factors to determine if the presumption is rebutted:

   1.                “[w]hich party invented or created the mark;”

   2.               “[w]hich party first affixed the mark to goods sold;”

   3.               “[w]hich party’s name appeared on packaging and promotional materials in conjunction with the mark;”

   4.               “[w]hich party exercised control over the nature and quality of goods on which the mark appeared;”

   5.               “[t]o which party did customers look as standing behind the goods, e.g., which party received complaints for defects and made appropriate replacement or refund;” and

   6.               “[w]hich party paid for advertising and promotion of the trademarked product.”

The Court explained it is inappropriate to apply the factors in a mechanical fashion.  Rather, each element’s weight is evaluated in light of the specific facts of the case.  If a court determines the factors are in equilibrium, then the distributor did not overcome the presumption, and the manufacturer owns the trademark, as was held in Covertech.

The Court’s holding is clearly a positive for manufacturers, and distributors must now take care to use formal contracts if they want to ensure they will have rights to the trademark being used.  The decision is beneficial to both manufacturers and distributors because it establishes a definitive test for federal District courts to apply, and it provides clear guidance for attorneys and their clients when structuring manufacturer/distributor relationships.  The holding also offers the benefit of greater uniformity across the US for parties operating in multiple states.  Courts of the Second, Fourth, Seventh and Ninth Circuits apply the McCarthy test in some form to determine the ownership of a trademark in this context.  This benefit is particularly significant for companies doing business in states neighboring those in the Third Circuit (New Jersey, Pennsylvania and Delaware), like New York, Virginia, and Maryland.

While the holding clearly has its benefits, one disadvantage is the potential for increased litigation costs resulting from the need to collect facts in discovery pertaining to each of the McCarthy factors.  This is yet another reason business partners need to establish their respective trademark rights contractually, thereby avoiding the McCarthy test altogether.

Last week I was fortunate to attend the Managing the Trademark Asset Lifecycle Conference, hosted by World Trademark Review.  The topics discussed throughout the day touched on everything from assessing portfolio strength and valuation to leveraging the financial value of a brand.  Although it is impossible to touch on all the points covered during this full-day conference, there were several high-level takeaways worth sharing.

  • The Three F’s of Intellectual Property Audits: Foresight, Fluidity And Flexibility. As with many facets of corporate life, too many companies wait to audit their Intellectual Property (“IP”) until the need arises.  This approach often leads to unnecessary scrambling, stress and lost opportunities.  Rather than taking a defensive or reactive approach to auditing, companies should think proactively, instituting budget-appropriate processes whereby data is routinely collected and maintained in accessible form.
  • Getting Rid Of The “IP Department” Mentality. One of the biggest mistakes a company can make is to limit the involvement of in-house IP counsel or the portfolio management team in the day-to-day management of the company.  IP affects all aspects of the company, from marketing and sales to international tax and finance, and IP counsel should be involved in all meetings where such issues are being discussed.
  • In-House Counsel As Brand Ambassadors and Educators. IP counsel and portfolio managers should be acting as brand ambassadors, not enforcement agents.  Although there may be instances where reactive steps must be taken, every effort should be made to continuously and positively educate company personnel regarding the use and importance of IP which, at the same time, should create additional enthusiasm regarding the brand.
  • The New IP Portfolio: Not Your Grandparents’ IP. Although obvious to some, companies need to recognize that IP is no longer simply about trademark and copyright registrations.  IP touches all aspects of a company’s public persona, from its customer lists and goodwill to its website, internet domains/extensions, and social media handles.  These valuable assets can no longer be ignored.
  • Attorneys As Revenue Generators: Help Me Help You. Attorneys are often brought in when an issue arises (the reactive/defensive approach).  However, IP attorneys are uniquely equipped with the insight and experience to add value and identify potential opportunities that may be overlooked by corporate decision-makers.  IP attorneys cannot identify opportunities if they remain in the dark as to the day-to-day operations and goals of the company.  Taking time to brainstorm with counsel is an investment worth making.
  • Adjusting To The Times: The Evolution of a Brand. Companies that refuse to recognize change or are resistant to evolving their brands will be left behind.  One great example came from Colm Dobby, Associate General Counsel for Mastercard Inc., who discussed the evolution of the “Master” brand in light of the fact that “Cards” are no longer the only or preferred mechanism to purchase goods and services with credit.
  • Beware Of Domain-Driven Branding. The Internet has revolutionized the way companies market and sell their goods and services.  As a result, many companies now consider an Internet domain more important than the overall brand itself.  In some cases, companies will look to the availability of a particular domain when considering a new brand.  Others have initiated a process of buying up all potentially similar domains (and domain extensions) to discourage others from building a brand based solely on the availability of a particular domain.  Although domains are undeniably important, companies should not be blind to other considerations when analyzing the strength of a brand.