California To Draw The Lines In Disparagement Liability

The California Supreme Court has granted review of the Court of Appeal’s decision in Hartford Casualty Insurance Company v. Swift Distribution, Inc., 210 Cal. App. 4th 915 (2d Dist. Ct. App. Oct. 29, 2012), review granted 152 Cal. Rptr. 3d 420 (Feb. 13, 2013).  Swift will resolve a hot debate about the scope of implied disparagement liability under California law.  The result likely will determine whether insurers must defend a variety of lawsuits involving allegations of intellectual property infringement, unfair competition and false advertising.

Commercial general liability (CGL) policies cover liability for “personal and advertising injury,” among other things, which often is defined to include “[o]ral, written or electronic publication of material that slanders or libels a person or organization or disparages a person’s or organization’s goods, products or services . . . .” 

The addition of disparagement liability coverage is significant for insureds.  It extends the insurer’s duty to defend beyond a mere defamation claim to a lawsuit involving an insured’s allegedly false statements about a competitor’s product.  Such allegations can arise in trademark infringement, unfair competition and false advertising cases, among others.  Because an insurer must defend the entire case if only one allegation could lead to covered damages, the defense protection available under a CGL policy’s disparagement coverage can be extremely valuable to insureds in a variety of business disputes.

In California, disparagement “may consist of the publication of matter derogatory to the plaintiff’s title to his property, or its quality, or to his business in general.”  Atlantic Mut. Ins. Co. v. J. Lamb, Inc., 100 Cal. App. 4th 1017, 1035 (2002).  To qualify as “disparagement”, an “injurious falsehood [must] specifically refer” to “the derogated [] product.”  Total Call Int’l, Inc. v. Peerless Ins. Co., 181, Cal. App. 4th 161, 169-170 (2010).  The reference can be either express or “by reasonable implication.” Blatty v. New York Times Co., 42 Cal. 3d 1033, 1046 (1986).

The Court of Appeal in Swift held that an insurer did not have a duty to defend its insured against allegations that it had infringed a competitor’s trademark and patents by producing and selling a similar looking music equipment cart with a very similar name (“Multi-Cart” vs. “Ulti-Cart”).  210 Cal. App. 4th at 923-929.  The appeals court rejected the insured’s argument that the allegations triggered a duty to defend under its general liability policy’s “personal and advertising injury” coverage for liability arising from “disparage[ment] [of] a person’s or organization’s goods, products or services . . . .”  Id.  The court found no potential for liability based on disparagement, either express or implied, reasoning that the insured was not alleged to have identified the competitor or its product, or to have suggested that the insured’s product was superior to that of the competitor.  Id.

The Court of Appeal’s decision in Swift was one in a series of recent decisions by California appeals courts and federal district courts reflecting a struggle to define the boundaries of “disparagement by implication.”  While there appear to be some common trends in the opinions, there also is tension among a few of them.  Indeed, the Court of Appeal in Swift expressly repudiated the decision of another panel from the same district on the same issue.  See 210 Cal. App. 4th at 925-926, discussing Travelers Property Cas. Co. of America v. Charlotte Russe Holding, Inc., 207 Cal. App. 4th 969 (2d Dist. Ct. App. 2012).  This likely contributed to the Supreme Court’s decision to grant review in Swift.

Courts have ruled as follows:

• Duty to defend triggered by allegations that insured falsely told competitor’s customers that the competitor’s products were burdened with patents and that purchasing the products would subject the customers to litigation.  Atlantic Mut. Ins. Co. v. J. Lamb, Inc., 100 Cal. App. 4th 1017, 1034-1035 (2002).
• Duty to defend triggered by allegation that the insured’s statement in its advertisements that it was the “only” producer of “all Java” and “fully J2EE” software solutions was false because the plaintiff also offered products with those features.  The court reasoned that the insured’s advertisement implied that the plaintiff’s product was inferior to the insured’s products.  E.piphany, Inc. v. St. Paul Fire & Marine Ins. Co., 590 F. Supp. 2d 1244, 1252-1253 (N.D. Cal. 2008).
• Insurer had no duty to defend an action alleging that insured prepaid phone card provider undercut the phone card market and then misrepresented to phone card consumers the number of minutes the consumer would receive on a phone call when using its phone cards.  Even though the underlying complaint expressly alleged that the insured’s advertisements were damaging the reputation of the plaintiff competitor and the industry, the court reasoned that “the complaint contain[ed] no allegations suggesting that the falsehoods met the specific reference requirement” because a consumer would have to reference the competitor’s own advertising to compare the competing products.  Total Call Int’l, Inc. v. Peerless Ins. Co., 181 Cal. App. 4th 161, 171 (2010).
• Duty to defend triggered by allegations that the insured falsely represented to a third party that it owned a trademark, which the claimant allegedly owned.  The court reasoned that the insured’s alleged misrepresentation implied that what it was offering to the third party was more valuable than what the claimant had to offer.  Burgett, Inc. v. American Zurich Ins. Co., 830 F. Supp. 2d 953 (E.D. Cal. 2011).
• Insurer had no duty to defend allegations that insured employed two ex-employees of a competitor, and the insured used those employees to make false representations about its experience and track record to “steal” customers and interfere with business relationships.  The court reasoned that the insured was not alleged to have compared itself to the competitor by implying “that it was the only producer of certain products or services, that it offered services superior to those of its competitors, or that it promoted its inferior products as its competitors’ superior products.”  Bullpen Distr., Inc. v. Sentinel Ins. Co., Ltd., 2012 WL 1980910 at *5 (June 1, 2012).
• Duty to defend triggered by allegation that insured furniture store staged cheap “imitation” products in its showroom when representing that it was selling the underlying plaintiff’s products.  The court reasoned that consumers were likely to assume that the “imitation” products were those of the underlying plaintiff, injuring its trade dress.  Michael Taylor Designs, Inc. v. Travelers Property Cas. Co., 761 F. Supp. 2d 904, 911-912 (N.D. Cal. 2011), affirmed by 2012 WL 5385598 (9th Cir. Nov. 5, 2012). 
• Insurer did not have a duty to defend allegations that insured falsely implied in advertisements that its food supplement product was equivalent to a competitor’s product by misleadingly suggesting that a study performed on the competitor’s product applied to its own product.  The court reasoned that “reference to the study was not, by implication, a reference to” the competitor’s product, and the insured was not alleged to have suggested that the competitor’s product was inferior to that of the insured.  Jarrow Formulas, Inc. v. Steadfast Ins. Co., 2011 WL 1399805 (C.D. Cal. Apr. 12, 2011), affirmed by 2013 WL 572192 at *1 (9th Cir. Feb. 15, 2013).
• Duty to defend triggered by allegations that insured retailer’s offer to sell so-called “premium” “high-end” clothing at steep discounts because this impliedly disparaged the plaintiff’s clothing by communicating to consumers that it was not “premium” “high-end.”  Travelers Property Cas. Co. of America v. Charlotte Russe Holding, Inc., 207 Cal. App. 4th 969, 978-981 (2012).

There appear to be some common threads that run through these cases.  For example, courts have found potential liability for implied disparagement where the insureds have falsely suggested that their products are superior to those of their competitors, even if no specific reference to the competitor is made.  See E.piphany, 590 F. Supp. 2d at 1252-1253 (insured asserted its product was the “only” one with particular software functionality); Burgett, Inc., 830 F. Supp. 2d at 964 (insured asserted right to trademark that was allegedly owned by its competitor). 

On the flip side of the same coin, courts have found no such potential liability where there is no claim of superiority.  These cases typically involve insureds who are trying to boost their reputations by associating themselves with established competitors.  See Bullpen, 2012 WL 1980910 at *5 (insured’s co-opted competitor’s experience and business relationships by hiring away two employees); Jarrow, 2013 WL 572192 at *1 (insured co-opted study by suggesting that it was based on testing of its product when it actually was based on testing of a competitor’s product).

Absent a claim of superiority, the courts generally have required some specific reference to the competitor or its products.  See Atlantic Mut., 100 Cal. App. 4th at 1034-1035 (insured entitled to defense where it allegedly told competitor’s customers that competitor’s products were burdened by patents); Charlotte Russe, 207 Cal. App. 4th at 978-981 (insured entitled to defense for allegedly discounting competitors’ products); Total Call, 181 Cal. App. 4th at 171 (insured not entitled to defense where it was alleged to have made false statements about its own product, not a competitor’s product); Bullpen, 2012 WL 1980910 at *5 (insured not entitled to defense where it allegedly co-opted competitor’s experience and business relationships by hiring away two employees, but never specifically referenced the competitor).

Enter Swift.  There, the insured arguably did not assert that its product (the “Ulti-Cart”) was superior to its competitor’s product (the “Multi-Cart”).  Rather, it was attempting to essentially trade on the good will that its competitor had developed in its product.  This seems to explain why the appeals court found no duty to defend. 

But the entire claim in Swift was premised on consumer confusion.  That is, because the products and their names were very similar, the plaintiff contended that consumers would end up associating the insured’s lower quality product with its own, thereby harming the reputation and strength of its brand.  The Court of Appeal explained that the plaintiff alleged in an application for temporary restraining order “that [the insured’s] use of a near-identical mark was detrimental to [the plaintiff’s] trade reputation and good will . . . [and] that the infringing ‘Ulti-Cart’ mark would be used to [the plaintiff’s] detriment since he would have no control over the nature and quality of [the insured’s] carts . . . [and] that any fault with those goods would adversely affect [the plaintiff]’s future sales and would tarnish his name and reputation.”  Swift, 2010 Cal. App. 4th at 922. 

These allegations seem to precisely fit the definition of “disparagement by implication” and, alone, should have been sufficient to trigger the insurer’s defense duty.  They also are similar to the facts of Michael Taylor Designs, in which the court found that an insurer had a duty to defend allegations that the insured was associating lower quality “imitation” products with those of the plaintiff.  761 F. Supp. 2d at 911-912.

The appeals court in Swift gave the allegations of reputational harm short shrift, however, seemingly intent on narrowing the scope of “disparagement by implication” liability.  Indeed, while the facts of Swift were quite different than those in Charlotte Russe (alleged disparagement by steeply discounting “premium” goods), the Swift court went out of its way to criticize Charlotte Russe.  Swift, 210 Cal. App. 4th at 925 (“we disagree with the theory of disparagement apparently recognized in Charlotte Russe. . . .  A price reduction may allegedly be injurious to the brand or its high-end, high-quality reputation, but it is not false and is thus not disparagement”). 

In an interesting twist of timing and demonstrating the uncertainty in this area, the Ninth Circuit  in Jarrow relied on Swift in rejecting an insured’s argument that it was owed a defense against allegations that it falsely associated its food supplement product with that of the plaintiff.  The Ninth Circuit heard argument in Jarrow one week before, and issued its decision two days after, the Supreme Court granted review in Swift.  It is unclear whether the Ninth Circuit was aware of the Supreme Court’s decision to review Swift before it relied on the uncitable Swift appeals court decision two days later.  The Ninth Circuit’s citations to the Swift appeals court decision do not indicate that it was.

The California Supreme Court’s forthcoming decision in Swift should bring some clarity and certainty to this area of the law.  Whichever way it goes, it should draw some clearer boundaries at the outer edge of the tort of disparagement.  This will allow insureds to more precisely determine whether they are entitled to an insurer-funded defense in various business disputes involving claims relating to intellectual property disputes, unfair competition and false advertising.