Earlier this year. we reported on the UK Government Consultation to determine the UK's future regime for importing parallel goods into the UK (following the UK's departure from the EU), and the extent to which intellectual property rights holders and their authorised licensees can prevent such trade. Key stakeholders, including IP owners, distributors and consumers alike, were invited to provide their views on which regime relating to exhaustion of IP rights should be implemented. The consultation period ended on 31 August 2021 and we now await the Government's response.
Much of the media focus on the consultation has centred on the potential impact for the publishing industry. However, it is clear that any change from the current exhaustion system will have "far-reaching effects" across numerous business sectors. One of the sectors most likely to be affected is the beauty industry: historically, beauty products, including cosmetics and fragrances, have been amongst the most parallel-imported (due to e.g. fragrance and cosmetics having a broader distribution). It is therefore important that those in the beauty industry understand the effects – positive or negative -- that each regime could bring. In particular, if an international exhaustion regime is chosen, beauty brands could find themselves unable to prevent genuine parallel goods being imported into the UK from anywhere in the world – a drastic change from the status quo.
What are 'parallel imports'?
Parallel imports (as defined in the consultation) are goods that are lawfully manufactured by a rights holder or under licence and are lawfully first placed on the market, and then moved across territorial borders. This is often in order to benefit from price differentials in different markets (alongside other contributing factors).
Rules relating to exhaustion of IP rights prevent an IP owner exerting control over the movement of such goods in certain circumstances. The European Union/EEA applies a regime of EEA-wide exhaustion. This means that when an IP owner puts goods on the market (or they are put on the market with their consent) within the EEA, they cannot enforce their IP rights in relation to those goods to prevent their resale in the EEA (except in limited circumstances). Following an EU Court of Justice decision in 2008 (Silhouette), EU Member States are prohibited from adopting an international exhaustion regime. This means that goods put on the market outside of the EEA cannot be imported into the EEA without the IP holder's consent.
Which exhaustion regime?
There are a number of key points arising out of the different models under consideration for the beauty industry.
UK+ regime – maintain unilateral participation in the EEA regional exhaustion regime
This is the current exhaustion regime, in place in the UK since it left the EU. Under this regime, goods put on the market in the EEA can continue to be imported into the UK without requiring the consent of the relevant IP owner. However, the same does not apply the other way around: where goods are put on the market in the UK, the relevant IP owner may be able to prevent the goods being exported to the EEA, as its IP rights will not have been exhausted. Since the UK (and the majority of Europe) spent most of this year in lockdown, the true effect of the absence of reciprocity now applicable under this regime has not yet been felt.
National exhaustion regime
Under a national exhaustion regime, IP rights in beauty products would be considered exhausted in the UK only when they are placed on the market in the UK. This option therefore would allow beauty brand owners to prevent the unauthorised importation of genuine parallel goods into the UK, thereby affording IP owners more automatic control over distribution of goods without setting up complex supply chains or selective distribution networks (see below).
However, despite perhaps being the preferred option for many brand owners in the beauty industry, the Government's position is that such a regime is not reconcilable with the Northern Ireland Protocol (though this interpretation is subject to some debate). Accordingly, as an option, the Government included in in the consultation for 'completeness' only.
'Mixed regime, potentially comprising differing approaches for different sectors (e.g. the beauty sector or 'luxury goods') products and/or IP rights'
Given practical difficulties, including in terms of defining what is meant by a 'luxury' good, it is thought that a mixed exhaustion regime would be difficult to put in place, and is therefore not a likely outcome. Again, the Government has raised concerns about compatibility of such a regime with the Northern Ireland Protocol.
International exhaustion regime
Under this option, parallel import of beauty products into the UK would be automatically permitted from any country in the world. This option is likely to make it easier for unauthorised resellers to obtain and import beauty products intended for other markets; under this regime, therefore, there would likely be a large rise in parallel imports being brought into the UK from outside the EU (in addition to those already permitted from the EU).
Beauty brands may therefore need to look to different methods or business structures to ensure the integrity of their supply chain, secure the efficacy of parallel-traded product in question and thereby the reputation of the brand itself. Even where the possible implications associated with an international exhaustion regime are not unique to the beauty industry, they are likely to be felt more profoundly, for example:
Allowing the parallel import of product intended for other markets increases the risk that out-of-date, compromised, or incorrectly-stored products may be imported into the UK. An increased inability to prevent the parallel import of genuine products may also lead to a decreased ability to effectively manage excess product and territory-specific stock inventories, on a global basis, thereby increasing the risk that the import of such out-of-date products go unnoticed.
Many beauty products e.g. fragrances and cosmetics, have higher consumer safety risk profiles than other products. Beauty products also often have a limited shelf life or require specific storage and transport conditions: fragrances and nail polish, for example, are considered hazardous goods which carry specific transportation requirements. With increased parallel-trade, and with such goods arriving in the UK from countries located increasingly further away (and with vastly differing climates), there is an increased risk that such parallel-imported beauty products may be old stock, or may not have been kept in optimum conditions. As a result they may be damaged, or presented or packaged in a manner affecting the integrity of the product. This could mean that the beauty product in question is, at best, no longer efficacious or, at worst, could have consumer safety implications, giving risk to product liability claims. This risk is more pronounced in the case of cosmetics which contain active or medical-grade ingredients.
Consumer satisfaction / brand reputation
The above risks also carry implications for brand reputation, particularly in circumstances where brands are unable to control the environment in which such parallel-imported beauty products are sold. It is also unlikely that sellers of unauthorised parallel products will offer an equivalent level of after-sale care. No matter the source of branded products, consumers will understandably look to the brand in question for any omission in quality or service. In particular, standalone luxury beauty brands or luxury fashion houses with beauty offerings may also find that the above may inhibit their ability to maintain the luxury retail experience for the consumer and thereby the 'aura' of luxury, which is often built up over years e.g. through carefully selecting and managing a network of approved partners.
Non-compliance with applicable law
Cosmetic products also regularly need to comply with specific regulations governing, for example, lists of ingredients or other product packaging requirements, especially if hazardous. Simply because a cosmetic product's packaging is intended for another market and complies with the regulations applicable in that territory does not mean that the same packaging would be compliant in the UK. This is especially so where products are parallel-imported from outside the EU (without the benefit of e.g. harmonised law across EU territories of which the UK until recently formed part, making it more likely that the packaging would be compliant with it in the UK).
Policing counterfeit goods and other considerations
The introduction of an international exhaustion regime is also likely to make it more difficult for IP owners to police and prevent counterfeit products entering into the UK and also to confirm the provenance of products claimed to be genuine.
In addition, some argue that an international exhaustion regime, if introduced, would lead to an inability for beauty brands to control pricing in the UK (given that international price differentials are common in fragrance and beauty) and therefore product from a lower-cost territory could be introduced at a lower price point in the UK, undercutting genuine product that has not been imported). However, a parallel trader’s income is through exploitation of any price differential, so any price difference may not be passed onto the consumer.
Outcome of consultation
The level of stakeholder input on the consultation is likely to have been high; as a result, the Government may take some time to publish its findings and identify the option which it considers best serves the UK. Even when the new regime is chosen, there may be a lengthy implementation period of up to a number of years during which the UK will remain in its current 'UK+' system.
In the meantime, there are a number of steps that beauty brands can take to future proof against the unknowns of the UK's future exhaustion system. These include:
- Integrated production models: Brands may seek to integrate production into the business in addition to the distribution and supply chain (which are more commonly brought in house) or outsourcing less of the manufacturing process.
- Selective distribution networks: Selective distribution (SD) networks are often used by larger beauty brands within the UK and the EU as a means of prohibiting unauthorised sales and thereby ensuring the integrity of the supply chain and provenance of goods. SD networks function by requiring SD partners to adhere to a specific – and often stringent – set of criteria. SD networks may operate to mitigate the effects of parallel imports by unauthorised resellers, but only to a certain degree. In addition, in the event of an international exhaustion regime, the increased presence of unauthorised sellers (selling the same product but without having to adhere to such criteria) may undermine the relevance, and the attractiveness, of such SD networks. Smaller or new market entrants may be unable to integrate SD networks into their business structure, and may be left more exposed as a result.
Increased investment in brand protection: To mitigate the effects of increased parallel trade, beauty brands may consider investing further in anti-counterfeiting resources and activities. Blockchain technology may also assist in tracking the provenance of parallel-traded goods. However, both such measures would come at an added cost to the business and blockchain is arguably only a viable solution for products sold at a higher price point.