SCOTUS to Consider Whether Non-Party Corporate Affiliate Profits are at Risk

Can a court force a company to disgorge its profits without being sued? The U.S. Supreme Court will take up this question in its next term. The question arises after the federal Fourth Circuit of Appeals affirmed an award of $43 million, the profits of non-parties to the suit.

That decision could have huge consequences for corporations. Businesses have long used the holding company model of ownership to insulate separate business ventures from the risk of losing assets because of a related businesses liability. If this ruling is affirmed, that model of risk management will take a significant blow.

The Controversial Damage Award Arises out of a Trademark Battle

Two competing companies, Dewberry Group and Dewberry Engineers, have battled over trademark rights to the name “Dewberry” since 2006. Each company uses the name to market their respective real estate development services. After an initial settlement was breached, the court granted summary judgment to Dewberry Engineers.

Trademark Infringement Remedies Include Disgorgement of Profits

At the damages trial, the trial court ordered the disgorgement of Dewberry Group’s profits as a remedy for trademark infringement. In a trademark infringement action, damages are typically measured by any direct injury which a plaintiff can prove, plus any lost profits which the plaintiff would have earned if the infringement had not occurred. Since actual damages are often difficult to prove, disgorgement of the defendant’s profits may be awarded. The profits remedy is designed to compensate the plaintiff for sales it lost because they were diverted to the defendant.

The federal Lanham Act gives broad discretion to courts to fashion equitable remedies for trademark violations. Specifically, the Act provides that if the court finds “that the amount of recovery based on profits is either inadequate or excessive, the court may in its discretion enter judgment for such sum as the court shall find to be just, according to the circumstances of the case.”

What Profits Can Be Forced to be Disgorged?

Here, the court used the disgorgement theory to calculate damages. However, the Dewberry Group did not have any profits, but many of its affiliated companies did. Exercising its equitable powers, the court ordered the disgorgement of the Dewberry Group’s affiliates’ profits, approximately $43 million.

On appeal, a split Fourth Circuit affirmed the award. The dissenting member of the appellate panel that heard the appeal wrote, “I know of no law that allows courts, in assessing the profits of a defendant, to disregard those options and simply add the revenues from non-parties to a defendant’s revenues for purposes of evaluating the defendant’s profits.” The Supreme Court will determine whether the Lanham Act is such a law.

The dissent said considering affiliate profits violated the separateness between different legal entities. The dissent pointed out that Dewberry Engineers could have sought those profits by suing the separate entities or proving that the corporate veil between these entities should be pierced. Then, the affiliates would have had an opportunity to defend themselves, either by showing that they did not participate in the infringement or that they maintained appropriate corporate separateness.

Dewberry Group asked the Supreme Court to take its case, arguing the decision violates the “strong presumption” that affiliates are to be treated as separate corporate entities. It argued that the Fourth Circuit’s opinion “silently invites courts to ignore corporate separateness without regard to veil-piercing principles.” Professors from Notre Dame Law School filed an amicus brief, arguing that equity “has never authorized courts to run roughshod over foundational principles of corporate separateness based on a sense of what would be most fair in an individual case.”

Dewberry Group also pointed out that the Fourth Circuit's decision conflicted with decisions by the Ninth and Eleventh Circuits. The Supreme Court often seeks to resolve circuit splits to provide uniformity in the law.

Finally, Dewberry Group also argued that disgorgement under the Lanham Act, the federal statute governing trademark law, must "constitute compensation and not a penalty.”

Consideration for Trademark Defendants

Until the Supreme Court decides the legality of forced disgorgement of affiliate profits, companies embroiled in trademark litigation must take steps to protect their affiliates’ profits:

• • Conduct discovery to identify exactly what damages the plaintiff is seeking
  • Consider having affiliates intervene in lawsuits to prove corporate separateness and
  • Move to exclude evidence related to affiliates.

Please contact Andrew Coffman, Mary Ellen Roy or any member of the Phelps Intellectual Property team if you have questions or need advice or guidance.