EXECUTIVE
SUMMARY | RECENT FASB RULE
CHANGES HAVE MADE IT IMPORTANT
for CPAs to understand the
concept of “trade dress” and its impact on
a company’s financial statements. Trade
dress refers to the unique packaging or
appearance of a company’s product, such as
the red and white Campbell’s soup can
label.
IN ALL BUSINESS
COMBINATIONS AFTER JUNE 30, 2001,
an acquiring company must
separately value the acquired company’s
trade dress. CPAs also must perform an
annual test, comparing the current fair
value of a company’s trade dress to its
recorded amount and recognizing an
impairment loss if it has gone below
this amount.
OVER THE LAST TWO
DECADES, THE COURTS HAVE
greatly expanded trade dress
protection to include the totality of
elements used to present a product,
including its design and features such
as size, shape, color, texture and even
sales technique. Companies can register
specific elements of a product’s trade
dress as trademarks under the Lanham Act
of 1946.
USING RECENT U.S.
SUPREME COURT RULINGS, CPAs
can help companies establish and enhance
the value of their trade dress by
assembling the proper documentation.
Factors the courts will look at include
direct consumer testimony, sales and the
behavior of competitors.
AS THE TRADE DRESS
RULES EVOLVE IN THE COURTS
and in state legislatures, CPAs
need to keep up with these changes to
ensure a company properly values these
intangible assets for financial
reporting purposes. |
ELISE K. PROSSER, PhD, is
assistant professor of marketing at the
School of Business Administration,
University of San Diego. Her e-mail
address is eprosser@sandiego.edu
. JAMES K. SMITH, CPA, JD, PhD, is
assistant professor of accounting at the
University of San Diego. His e-mail
address is smithj@sandiego.edu
. |
s a result of rule changes by the
Financial Accounting Standards Board, “trade
dress” has become an important concept for CPAs to
understand. Statement no. 141, Business
Combinations, requires companies entering
into such combinations after June 30, 2001, to
separately value the acquired company’s
significant intangible assets. Statement no. 142,
Goodwill and Other Intangible Assets,
requires companies to value these assets at
least annually. One asset companies must value
under these rules is trade dress, which refers to
a company’s unique packaging or the design
presentation of its product. Competitors are not
allowed to imitate another company’s trade dress
in a manner that confuses consumers. The value of
a company’s trade dress—such as the red-and-white
label of a Campbell’s soup can—is subjective and
largely influenced by how broadly or narrowly the
statutes and court decisions define trade dress
protection. The Lanham Act of 1946
established the applicable federal law, but the
courts’ interpretation often has more influence on
what trade dress law protects. Several recent U.S.
Supreme Court decisions are the culmination of 22
years of change in this area, with trade dress
rules first becoming significantly more liberal,
then more conservative over the last seven years.
Each expansion or contraction of these rules has
important implications for the value of a
company’s trade dress and may lead to financial
statement losses under Statement no. 142.
CPAs
need to keep abreast of legal developments
in this area to accurately value trade
dress for purposes of Statement nos. 141
and 142. In addition, familiarity with
these rules will allow accountants to help
a company document the creation and
maintenance of its trade dress. Recent
court decisions indicate this type of
documentation is necessary before certain
types of trade dress are entitled to
protection. |
What Is Trade
Dress?
The red and white
Campbell’s soup can label.
The shape of a
Coca-Cola bottle.
McDonald’s golden
arches.
The design and
decor of a TGI Friday’s
restaurant.
The bright yellow
Cheerios box.
| |
FASB 141 AND 142
Statement no. 141
requires all companies entering into business
combinations after June 30, 2001, to use the
“purchase” method of accounting and eliminates the
“pooling” method. (See “Say
Goodbye to Pooling and Goodwill Amortization,”
JofA , Sep.01, page 31, for more
details.) The purchase method requires the
acquiring company to separately recognize all of
the acquired company’s significant intangible
assets including goodwill (the difference between
the purchase price and the fair market value of
the acquired company’s net assets). The company
also must recognize any other intangible assets
that either arise from a contractual or other
legal right or can be separated from the acquired
entity and sold, transferred, licensed, rented or
exchanged. Trade dress is among the intangible
assets listed in Statement no. 141 that meet at
least one of these two criteria. As a result, an
acquiring company in a business combination is
required to separately value the acquired
company’s trade dress. One controversial
aspect of Statement no. 141, raised during its
public comment period, was the negative effect it
might have on earnings as a result of the
amortization of additional intangible assets. FASB
addressed some of these concerns in Statement no.
142 by replacing the amortization of intangible
assets that have an indefinite life with an annual
impairment test. Under these rules, trade dress
has an indefinite life and is subject to an annual
impairment test. The test requires CPAs to compare
the current fair value of a company’s trade dress
to its recorded amount and recognize an impairment
loss if fair value has gone below that amount.
Companies also recognize impairment losses between
annual tests whenever events—such as a major legal
ruling—occur to indicate the entity’s trade dress
might be impaired. The impairment test replaces
amortization for fiscal years beginning after
December 15, 2001.
WHAT CONSTITUTES TRADE DRESS?
The traditional
definition limited protection to a product’s
packaging or “dressing.” The courts have greatly
expanded this protection over the last two decades
to include both the totality of elements used to
present a product (for example, the distinctive
decor of a restaurant) and the product’s design
(such as the shape of a flashlight). Trade dress
now is broadly defined to cover a product’s total
image and may include features such as size,
shape, color, texture and even sales techniques.
Examples of protected trade dress include the
design of a magazine cover, the shape of an
automobile, the design of a golf hole, the shape
of a cracker and the cowboy imagery used to
promote a brand of cigarettes. Companies
can register specific elements of a product’s
trade dress as trademarks under the Lanham Act,
but registration is not required for protection.
The majority of cases involve unregistered trade
dress, which is protected by section 43(a) of the
act. In either instance, federal courts have three
requirements for successful litigation: The trade
dress in question must be distinctive, it must be
nonfunctional and a competitor’s imitation of it
must confuse the consumer. For a
company such as Coca-Cola to gain
protection for its trade dress, the
imitator’s packaging must cause
confusion about the source of the
product.
| A
company meets the distinctiveness requirement by
showing its trade dress is either inherently
distinctive or has acquired this trait through
secondary meaning. Trade dress is inherently
distinctive if its intrinsic nature almost
automatically tells a consumer the source of the
product. For example, the appearance and decor of
a Mexican restaurant was held to be inherently
distinctive in the landmark Supreme Court case
Two Pesos Inc. v. Taco Cabana Inc.,
505 US 763 (1992). Acquiring distinctiveness
through secondary meaning is more difficult to
prove and requires a concerted effort on the
company’s part to associate a product with its
unique trade dress. For example, the Volkswagen
Beetle has almost certainly acquired
distinctiveness over many years as a result of
extensive advertising and promotional efforts.
Courts look at a number of factors, including the
company’s advertising and promotional efforts.
If the design of a product
is not essential to its purpose, the
courts will consider it nonfunctional
and perhaps entitled to trade dress
protection.
| The
nonfunctional requirement was intended to prevent
companies from obtaining perpetual monopolies on
products. Any aspect of a product’s trade dress
that is functional is not entitled to protection.
Trade dress is functional if it is essential to
the use or purpose of the product. For example,
the dual-spring design of a road sign was
considered functional and not entitled to
protection in a 2001 Supreme Court case
TrafFix Devices Inc. v. Marketing
Displays Inc., 532 US 23 (2001). On the
other hand, the courts may consider the design of
a product or its packaging—such as a pillow-shaped
breakfast cereal—not essential to its purpose,
making the attribute nonfunctional and perhaps
entitled to trade dress protection. For a
company to obtain protection, the imitator’s trade
dress must cause confusion about the source of a
product. To determine whether such confusion
exists, courts typically consider a number of
factors, such as the similarity of the two trade
dresses, the sophistication of the relevant
consumer group, the defendant’s intent and any
evidence presented of actual confusion. For
example, consumers might be confused if a generic
pain reliever used the same red and yellow color
pattern that Tylenol uses for its capsules.
RECENT TRENDS IN TRADE DRESS LAW
The
requirements for trade dress protection
and the definition of what relevant laws
protect have undergone significant changes
(see time line in exhibit 1, at right).
The courts and state legislatures
liberalized trade dress rules from 1980
through 1994 and then made certain areas
more stringent after 1994. These trends
are reflected in exhibit 2, below, which
shows the number of trade dress cases
litigated annually in federal district
court and the federal courts of appeals
since 1944. Exhibit 2, shows a surge in
cases starting in the early 1980s, with
the number steadily increasing through
1994. Cases declined after 1994 as the
legislative rules and court decisions
became more restrictive. CPAs need to be
aware of these trends because they have a
considerable impact on the value of
companies’ trade dress for financial
reporting purposes. | |
Exhibit 1: Trade
Dress Time Line
| 1946. Federal trade
dress laws codified in the
Lanham Act.
Early 1980s.
Courts expand the definition
of trade dress to include
product shape and design.
1981. Fifth
Circuit Court of Appeals
liberalizes the
distinctiveness requirement by
allowing that trade dress can
be inherently distinctive
without having to show it has
acquired distinctiveness
through secondary meaning.
1988. Congress
expands the definition of and
remedies for trade dress
within section 43(a) of the
Lanham Act of 1946.
1992. U.S.
Supreme Court rules that trade
dress is inherently
distinctive in Two Pesos
v. Taco Cabana.
Mid-1990s to
present. The trend in trade
dress rulings shifts from
liberal (rulings that made it
easier to prove trade dress
infringement) to conservative
(rulings that make it more
difficult). Various appeals
courts begin the conservative
trend with a series of rulings
in the mid-1990s.
1995. Supreme
Court holds that color by
itself is never inherently
distinctive and requires
secondary meaning in
Qualitex Co. v.
Jacobson Products.
1999. Congress
amends the Lanham Act to place
the burden of proving
nonfunctionality on the
plaintiff in cases of
unregistered trade dress.
2000. Supreme
Court holds that product
design, unlike product
packaging, is never inherently
distinctive and requires
secondary meaning in
Wal-Mart v.
Samara Bros.
2001. Supreme
Court strengthens the
nonfunctional requirement in
TrafFix Devices v.
Marketing Displays.
| |
In the early 1980s the courts expanded trade
dress protection. They went from protecting
product packaging only to also protecting a
product’s design (shape). This change allowed the
distributors of Rubik’s cube to protect both the
packaging and the appearance of its product in
Ideal Toy Corp. v. Plawner Toy
Manufacturer Corp., 685 F2d 78 (3rd Cir.,
1982). Another major expansion occurred in 1981
when the Fifth Circuit Court of Appeals
liberalized the distinctiveness requirement by
allowing trade dress to be inherently distinctive.
Before this ruling, courts required trade dress to
have acquired distinctiveness through secondary
meaning before it was entitled to protection.
The Fifth Circuit ruling was a major
breakthrough because proving inherent
distinctiveness might require a company to show
only that its trade dress was unique or even
unusual. Establishing acquired distinctiveness
requires proof of a major promotional and
advertising effort. For example, the manufacturer
of an igloo-shaped dog house was only able to
establish that its product had acquired
distinctiveness after proving the company had
conducted a seven-year advertising campaign that
resulted in the public’s associating the shape of
the dog house with the company ( Dogloo Inc.
v. Northern Insurance Co. of New York,
907 F Supp 1383 (1995)). The majority
of courts followed the Fifth Circuit ruling, but
there was still uncertainty until the Supreme
Court agreed in Two Pesos that trade
dress could be inherently distinctive.
Exhibit 2: Trade
Dress Cases in Federal Court
|
Source: Derived from
Westlaw federal
case database.
| |
| Three Supreme Court cases
within the last seven years reversed the
trend toward liberalized trade dress
rules, particularly regarding the
distinctiveness standard. Qualitex Co.
v. Jacobson Products Co.,
514 US 159 (1995) held that a
company’s use of color, by itself, is
never inherently distinctive and must have
acquired distinctiveness through secondary
meaning. The green-gold coloring of a dry
cleaner’s press pads at issue in this case
thus would have had to acquire
distinctiveness through secondary meaning
to be entitled to protection.
Wal-Mart Stores v. Samara
Bros., 529 US 205 (2000), further
restricted the distinctiveness standard.
The Supreme Court held that companies
must prove trade dress claims based on
product design through the acquired
distinctiveness standard. The Court
differentiated the more liberal Two
Pesos standard by ruling it
applied only to product packaging. As a
result, companies seeking to protect
product-packaging trade dress can prove
either it is inherently distinctive or
it has acquired distinctiveness while
companies seeking to protect product
design are limited to the acquired
distinctiveness standard.
| For example,
a snack food manufacturer may be able to prove
that its packaging is inherently distinctive
merely by showing it has a unique or unusual
design. A golf-club maker, on the other hand, may
need to plan years of advertising and promotional
efforts to show that its club (product design) has
acquired distinctiveness in the minds of
consumers. In Wal-Mart, t he Supreme
Court recognized that it is sometimes difficult to
differentiate product-packaging cases from
product-design cases and said that in such
uncertain situations companies must meet the
acquired distinctiveness standard.
A
golf-club maker may need to plan years
of advertising and promotional efforts
to prove its club has acquired
distinctiveness in consumers’ minds.
| The
trend toward more restrictive interpretations
continued in TrafFix Devices Inc., with
the Supreme Court’s limiting when trade dress is
considered functional and not protected. CPAs
should understand that the Court decisions in
these three cases are likely to make it more
difficult for businesses to successfully litigate
trade dress cases and may drive down the value of
certain companies’ trade dress.
ESTABLISHING TRADE DRESS
The rulings, however,
create opportunities for CPAs to help companies
establish and enhance the value of their trade
dress. Some of the decisions were very specific on
the documentation needed to confirm that a
company’s trade dress has acquired distinctiveness
through secondary meaning. Establishing such
meaning “does not happen by accident. Instead, it
requires affirmative and deliberate actions by the
person seeking to establish legal rights” in the
trade dress ( Chrysler Corp. v.
Vanzant, 44 F Supp 2d 1062, 1074
(1999)).
It’s more difficult for a
company to prove that a product’s design
has taken on secondary meaning. The
Volkswagen Beetle, for example, has
almost certainly acquired
distinctiveness as a result of extensive
advertising and promotional efforts.
| Courts
look to these factors to determine whether trade
dress has acquired secondary meaning. CPAs will
find them valuable as well when advising employers
and clients.
Exclusivity, length and manner of
use. This involves evidence that the
company has used the trade dress exclusively for
more than a short period of time. Changing the
trade dress by altering the product packaging or
appearance or by discontinuing its use for any
period makes it difficult to prove secondary
meaning.
Advertising. Companies need
to document the amount and manner of advertising
for the product. Obviously, the more spent the
better. The advertising needs to establish a link
between the trade dress and the company or
product. For example, Prestone might have had a
better case for establishing secondary meaning for
the trade dress of its antifreeze if its
advertising had encouraged consumers to look for
the “familiar yellow jug” instead of featuring the
product as a whole ( First Brands Corp.
v. Fred Meyer Inc., 809 F2d 1378
(9th Cir., 1987)).
Direct consumer testimony.
Any direct testimony a company can obtain
from consumers about their association between the
trade dress and the product is helpful in
establishing secondary meaning.
Consumer surveys. Survey
evidence showing a link in the consumer’s mind
between the trade dress and the product or company
has been held to be the most direct and persuasive
evidence of secondary meaning.
Unsolicited media coverage.
Evidence of unsolicited media coverage of the
product, particularly if it refers to the
product’s trade dress, supports secondary meaning.
Sales. Evidence indicating
large amounts of sales and customers, while not
sufficient by itself to prove secondary meaning,
is relevant to a claim that trade dress has
acquired secondary meaning.
Competitors’ behavior.
Evidence of the intentional copying of a
company’s trade dress by a competitor supports
secondary meaning.
Other promotional efforts.
Any other efforts by the company to promote a
connection between the trade dress and the product
can also be helpful. Management
accountants need to help a company document each
of these factors from the moment it introduces a
product to the market. While none of the factors
by themselves may prove to the courts that the
trade dress has acquired secondary meaning,
documentation the company has satisfied a number
of these considerations may prove more persuasive.
THE FUTURE OUTLOOK
The trade dress rules
are sure to continue evolving and accountants need
to pay close attention to legal developments so
they can properly serve their clients and
employers. CPAs can keep track of changes in trade
rules through the popular press, which is sure to
report major developments, and by consulting with
attorneys specializing in this area. By keeping up
with the changes, they can ensure proper valuation
of a company’s trade dress for financial reporting
purposes. CPAs can also help the company document
and protect the design and packaging of its
products. A business that fails to successfully
protect its trade dress from “copy cat”
competitors may soon find itself a victim of
declining sales and diminished profits. |