The best way to punish companies that lie to consumers

July 30, 2014

The 2nd Circuit U.S. Court of Appeals really pummeled the pharmaceutical manufacturing company Gnosis in an opinion Tuesday. Judges Rosemary Pooler, Reena Raggi and Richard Wesley affirmed that Gnosis must pay Merck more than $2.5 million in damages and attorneys’ fees for violating the Lanham Act with deceptive marketing about its folic acid product Extrafolate.

That’s not a lot of money for a global corporation, but it’s much, much more than Gnosis made from selling Extrafolate under false pretenses. The 2nd Circuit ruled that the lower-court judge who ruled against Gnosis after a bench trial in 2012, U.S. District Judge Richard Sullivan, was within his rights to award Merck three times the profits Gnosis realized from Extrafolate, even though the Lanham Act doesn’t authorize punitive damages. Gnosis’s egregious conduct — suggesting in marketing materials that its product was a pure isomer when, in fact, it was a mixture — justified an enhanced damages award, according to the 2nd Circuit, as well as the corrective advertising Judge Sullivan ordered.

The appeals court also rejected Gnosis’s argument that Merck hadn’t proved it was harmed by the supposedly false ads. The 2nd Circuit requires different proof depending on whether competitors are directly disparaged in false ads or are just in the same market as the deceptive advertiser, and Gnosis’s lawyers at Husch Blackwell contended that the company’s allegedly deceptive materials didn’t name Merck so Judge Sullivan erred in presuming Merck was injured. The 2nd Circuit said, however, that since Merck was the only company competing with Gnosis at the time of the false ads — and Merck actually produced the pure isomer Gnosis purported to be selling — it follows that Merck was damaged.

In short, the 2nd Circuit opinion shows that Lanham Act false advertising claims can be a powerful weapon against corporate deception, with a presumption of injury in a two-company market and the possibility that defendants will be required to issue ads to correct false information and pay treble damages and attorneys’ fees to the other side. If a company knows that it may have to shell out multiples of the profits it realizes from false ads, it’s going to think twice (or three times) before trying to dupe the marketplace.

Last month, I posited that Lanham Act false advertising cases are a more efficient device than consumer class actions for deterring consumer deception. (I was inspired by the U.S. Supreme Court’s 2014 decisions in Lexmark International v. Static Control Components and Pom Wonderful v. Coca-Cola.) The Gnosis opinion convinces me more than ever of that hypothesis.

We all know the drill in consumer class actions. Plaintiffs’ lawyers sue under state consumer protection laws on behalf of purchasers whose claims wouldn’t otherwise be worth pursuing. Defendants try to knock out cases with dismissal motions and opposition to class certification, but if a consumer class is certified, they agree to settlements that, typically, deliver so little cash to consumers that the vast majority of them don’t even bother to file claims. The cycle nevertheless repeats because settlements deliver big enough legal fees to plaintiffs’ lawyers to keep the class action bar running.

Who’s a scarier opponent for a deceptive corporation: a deep-pocketed competitor willing to go to trial and argue for enhanced damages or a plaintiffs’ lawyer incentivized to settle? I’d argue it’s the former, which means that the Lanham Act threat is a more effective deterrent than the risk of a consumer class action. The Lanham Act also reaches deceptive companies that ordinary consumers can’t touch. Gnosis, for example, didn’t sell its product directly to the public, but to six vitamin and supplement makers. Despite marketing material that Judge Sullivan and the 2nd Circuit considered to be flagrantly misleading, Gnosis was not targeted in a consumer class action because consumers didn’t buy Extrafolate.

The last time I wrote about the Lanham Act and consumer class actions, I noted that judges rarely order defendants to pay fees to the other side in false advertising cases. I said the cost of litigating was a sort of quality control, assuring that corporate rivals would only bring strong cases against competitors. I’m reconsidering that stance in light of the 2nd Circuit’s Gnosis decision. It cost Merck more than $2 million in fees and costs to prosecute its case against Gnosis, which involved actual damages of less than a tenth of that amount. If more judges followed the lead of Judge Sullivan and the 2nd Circuit, ordering deceivers to pay for the other side’s lawyers, more companies will be willing to sue rivals for deceiving the market.

I left messages with Merck counsel Natalie Clayton of Alston & Bird and Gnosis lawyer Laurie Haynie of Husch but didn’t hear back.

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