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LIZ CLAIBORNE, INC. v. MADEMOISELLE KNITWEAR

June 22, 1998

LIZ CLAIBORNE, INC. and L.C. LICENSING, INC., Plaintiffs, against MADEMOISELLE KNITWEAR, INC., individually and d/b/a THE MILL LTD. SWEATER FACTORY OUTLET; CHARLES STEFANSKY; VARIOUS JOHN DOES, JANE DOES and XYZ COMPANIES, Defendants.

ROBERT W. SWEET, U.S.D.J.


The opinion of the court was delivered by: SWEET

OPINION

Sweet, D.J.

 Plaintiffs Liz Claiborne, Inc. and LC Licensing, Inc. (collectively "Claiborne"), a nationally recognized merchandiser of fashion apparel, brought this action against defendant Mademoiselle Knitwear, Inc., individually and d/b/a The Mill Ltd. Sweater Factory outlet (collectively "Mademoiselle"), a garment manufacturer, Charles Stefansky ("Stefansky") and Shraga Newhouse, a/k/a Sy Newhouse ("Newhouse"). Claiborne alleged trademark infringement and unfair competition. Upon the trial before the Court and all the prior proceedings and the findings of fact and conclusions of law which follow, judgment will be entered in favor of Claiborne in the amount of $ 582,868 with costs and prejudgment interest.

 The rights and obligations of suppliers and merchandisers in the highly competitive multi-million dollar fashion market for trademarked women's sweaters are complicated, developed through a course of dealing and practices and subject to mutual understanding between the participants. Here an initial relationship was accomplished by friendship, and confidence in a joint enterprise initiated in 1991. When that confidence was lost as a result of changes in personnel, procedures and market forces, the relationship deteriorated ultimately to the point of this litigation undertaken early in 1996. Given the stakes involved, the litigation has been intense and conducted aggressively and ably by skilled counsel for both sides. Under these circumstances the factual issues as resolved below are controlling.

 The Parties

 Claiborne is a Delaware corporation with a principal place of business at 1441 Broadway, New York, New York. Claiborne has utilized in excess of two hundred contractors throughout the world to produce goods to its specifications and standards which goods complete in the fashion industry and bear Claiborne identification. Claiborne's sweaters were protected by its registered trademarks (the "Claiborne Trademarks").

 Mademoiselle is a New York corporation and does its principal business as a garment manufacturer at 930 Flushing Avenue, Brooklyn, New York. Mademoiselle manufactured garments for Sears and J.C. Penney before undertaking to manufacture sweaters for Claiborne.

 Defendant Charles Stefansky is an employee of Mademoiselle.

 Shraga Newhouse ("Newhouse"), now deceased, was at the relevant time President of Mademoiselle.

 Prior Proceedings

 This action was initiated by Claiborne on March 21, 1996, seeking damages for trademark infringement and unfair competition, as well as a temporary restraint and preliminary injunction. The application for preliminary injunctive relief was dropped and expedited discovery proceeded. A motion by The Blouse, Skirt Sportswear, Children's Wear and Allied Workers Union Local 23-25 (the "Union") to intervene was denied by an opinion of June 25, 1996.

 Some fifteen orders were entered relating to discovery and scheduling and on September 29, 1997, an opinion was filed denying Claiborne's motion for summary judgment. See Claiborne v. Mademoiselle, 979 F. Supp. 224 (S.D.N.Y. 1997).

 A bench trial was held from December 8, 1997, to January 7, 1998. Hundreds of exhibits were received and twenty-six witnesses were heard. Final submissions were made on March 27, 1998, at which time the action was considered fully submitted.

 Findings of Fact

 I. The Course of Dealing from 1991 Until the End of 1995

 Beginning in 1991, Claiborne and Mademoiselle began discussions about using Mademoiselle as a contractor and a manufacturer of Claiborne sweaters. The discussions included Mademoiselle's union status, and after entering into the relationship with Claiborne, Mademoiselle became a union shop.

 By the issuance of orders in the form of cutting tickets, Claiborne conferred authority in Mademoiselle to produce Claiborne knitwear goods (mostly sweaters) for delivery to Claiborne. The cutting tickets issued by Claiborne specified the quantity of goods, the style number and trademark to be used. In addition, Claiborne prescribed in the cutting tickets the date by which Mademoiselle had to ship to Claiborne's warehouse the goods specified (the "in-warehouse" date). The in-warehouse date generally preceded, by thirty days, the date the goods were to be in the stores (the "in-store date").

 The cutting tickets included requisitions not only for garments designed by Claiborne but also for garments designed exclusively by Mademoiselle or by Mademoiselle and Claiborne jointly.

 Mademoiselle employed a "modular" production system under which the component parts of a sweater pass through "modules" or stations on the way to being assembled. The modules in the order of the production process were knitting, washing, cutting/slicing, sewing, and shipping.

 In the knitting module, the yarn for making sweaters was knit into "panels." Panels were knit to yield eight to ten dozen garments of the same design and color, known as knitting "lots." These lots were then washed and transferred or "released" to the cutting (or slicing) module where each panel was cut into the component parts required to make a sweater. A sweater consisted of at least five components: a front, back, two sleeves and a collar, and additional components, such as pockets, were on occasion required. After the components were released from cutting into sewing, they went in bundles of parts required to make twelve units. After the component parts were assembled into a garment in sewing and passed an interim quality inspection, the garment was steam-pressed and taken to the packing stage of the sewing module where it was folded and placed into a plastic bag. After bagging, a final quality inspection of the garments was performed. Garments that passed final inspection were transferred to the shipping module where they were sorted by style, size and color and placed into twenty-four unit boxes that identified, on the carton, the garments contained within. Defective garments were referred to the production line for repair and, if the defect was repairable, proceeded through packing for final inspection again. Garments that never passed final inspection were either classified "irregular" or are discarded as waste if the defect was so severe as to render the garment unshippable even as an "irregular."

 Claiborne established an on-site presence at Mademoiselle to perform the "in-line" and "final" factory inspections of all Claiborne merchandise.

 From time to time in the normal course of production, Claiborne's contractors produced goods: (i) in excess of five percent of the quantity of garments authorized by Claiborne to be produced ("overruns"); (ii) that did not pass Claiborne's quality controls ("irregulars"); or (iii) past the date authorized by Claiborne ("stragglers" or "late goods"). Claiborne allowed its contractors to produce and send to Claiborne within the time period prescribed by Claiborne, five percent over or under the number of garments stated in a cutting ticket which deviations would be accepted without question or further procedure.

 Claiborne required its United States contractors to report, in writing, all irregulars to Claiborne, and Claiborne authorized shipment of irregulars to Claiborne by a "contractors Irregular/Overrun Authorization" form signed by or at the direction of the Manufacturing Director/Vice President of Manufacturing for the relevant Claiborne division. The contractor then shipped the irregulars to Claiborne. Claiborne's policy up until April 1993 was to accept all overruns and irregulars.

 Upon receipt at Claiborne's warehouse, Claiborne conducted a final inspection of every style within every shipment of goods and audited the shipments using the Military Standard 105D, a statistical sampling plan used by the apparel industry. A random sampling of 3-5% of garments from each shipment were pulled for inspection (the "inspection garments"), inspected for defects, and if the number of inspection garments containing defects was equal to or less than the acceptable level, the entire shipment was accepted as first quality. If the number of inspection garments containing defects was above the rejection level, the entire shipment was rejected, and corrective action was taken.

 II. Claiborne's knowledge of the Garments Produced by Mademoiselle

 Mademoiselle maintained a computerized production tracking system that reported on a module-by-module basis. The system generated at the final stage of each module an "extract file listing" that showed the quantity of "garments" (i.e., the quantity of component-part bundles required to make one sweater) input into the computer as the amount released from each module (i.e., knitting extract file listing, washing extract file listing, cutting (or "slicing") extract file listing, and packing extract file listing. The extract file listing for the knitting and cutting modules contained production data transposed from daily summary sheets prepared by that Module's manager relative to the knitting lots processed.

 Mademoiselle prepared and submitted to Claiborne weekly "work-in-process" reports showing, inter alia, the quantity of garments ordered that were in production and the scheduled "ship date." These reports documented the quantity and progress of the garments Claiborne ordered from Mademoiselle which indicated whether shortages or overages would result from any given production run relative to the quantity of first-quality garments ordered, or whether production would be completed before or after the ship date designated in the order as originally issued or as amended. Mademoiselle also reported to Claiborne the quantity of yarn purchased to fill Claiborne's orders.

 Jack Listanowsky ("Listanowsky"), then Vice President of Manufacturing and Operations, represented Claiborne in developing the relationship with Mademoiselle which started in the fall of 1991. In 1992 Claiborne issued cutting tickets to Mademoiselle calling for the production of 1.5 million units in the period from June 1992 to May 1993.

 III. The Decline of the Business Relationship

 Mademoiselle began to develop financial problems in 1992, resulting in a Chapter XI filing and reorganization. Mademoiselle borrowed $ 175,000 from Claiborne to upgrade its machinery, purchased high-speed knitting machines for over $ 1 million financed by the seller, borrowed $ 200,000 from Claiborne to purchase a yarn twisting machine, and Claiborne financed the yarn which Mademoiselle used to manufacture the Claiborne units. Newhouse, the president of Mademoiselle, anticipated a continuation of the Claiborne business at the same level as during the first year of the relationship based upon his conversations with Listanowsky.

 During the 12 to 14 month period prior to January 1, 1994, Claiborne decentralized with each division becoming its own profit center. Under this reorganization, individual division officials were compensated, in part, based upon the profits that their divisions earned on the garments sold. Following decentralization, Claiborne's divisional officials reported to Listanowsky that there were performance problems with Mademoiselle. Listanowsky investigated these charges and found them to be unsubstantiated and inconsequential. However, the profit margin on goods produced by union labor in the United States was less than what could be realized on goods made in non-union shops abroad. In 1994 the volume of units ordered by Claiborne from Mademoiselle fell. Newhouse protested this diminution of cutting tickets and sought an increase in the Claiborne orders. By early 1995, Claiborne increased the allocation of production to non-union factories off-shore.

 Listanowsky sought to reassure Newhouse that the Claiborne business would hold up, and Newhouse continued to press for reassurance and additional orders. Listanowsky who had been at Claiborne for fourteen years serving as executive vice president since 1991, had a close relationship to Newhouse who employed his wife. At the end of 1994, Harvey Falk was replaced by Paul Charron as Chief Executive Officer of Claiborne. Listanowsky left Claiborne in April of 1995 to become a vice president of The Limited with responsibility for procurement of goods.

 Claiborne was a member of the employers association, the New York Skirt and Sportswear Apparel Association, Inc., which had a collective bargaining agreement with the Union. The Union during this period sought reassurance from Claiborne that it would continue to obtain production from United States manufacturers. In an April 1995 letter, Claiborne confirmed its oral statement that it would order 50,000 sweaters a month from Mademoiselle from June 1995 through June 1997, continuing a similar commitment which had expired on May 31, 1995.

 In mid-1995, Mademoiselle and Claiborne initiated a proposal for manufacturing sweaters using Mademoiselle's newly patented cotton lyra blend technology, a proposal which gained acceptance at Claiborne in September 1995, notwithstanding the problems of timely delivery and quality which had been the subject of discussions. However, the negatives concerning Mademoiselle's performance outweighed the positives, and the proposal was abandoned. By letter of November 16, 1995, Claiborne advised Mademoiselle that "these results are completely unsatisfactory and do not represent a basis upon which the existing relationship can continue." Discussions to resolve the impasse were held without resolution.

 On December 4, 1995, the Union filed a complaint seeking arbitration to enforce its perceived commitment by Claiborne to order units from Mademoiselle. *fn1"

 On December 5, Mathew Gluckson, a Claiborne Vice President of manufacturing, noted in his diary a 3-4 months exit strategy involving Mademoiselle. When testifying subsequently he had no recollection concerning the entry or any discussion which gave rise to it. Sometime in December the present outside counsel for Claiborne was retained. On December 28, 1995, enforcement personnel of Claiborne received an anonymous telephone call from a person said to be a contract sewer to the effect that Mademoiselle was selling Mademoiselle garments with Claiborne labels at a store on Long Island on Glen Cove Road. An investigation into unauthorized sales by Mademoiselle was launched which culminated in the filing of this action in March, 1996.

 On April 24, 1996, letters from Claiborne's counsel abrogated any authority of Mademoiselle to sell any Claiborne merchandise to third parties.

 IV. The Claiborne Policy Permitting Sales by Mademoiselle to Third Parties

 The procedures and practices with respect to the disposition of overruns and irregulars (including stragglers) was set forth in the contractors manual issued by Claiborne and distributed to Mademoiselle (the "Contractors Manual"). During the period from the beginning of their relationship through November 1995, Mademoiselle offered and Claiborne accepted all overruns and irregulars reported by Mademoiselle as provided in the 1991 and 1993 version of the Contractors Manual. This was consistent with Claiborne's practice with respect to all its manufacturers.

 The sell-off of excess goods by a manufacturer was subject to three criteria, namely, that, as of the time such goods were presented for retail sale, the excess goods were (i) not current regular-line goods, (ii) appropriately marked (to correspond to quality) and (iii) the subject of an unexercised or relinquished "right of first refusal."

 These excess goods were finished garments that did not count towards fulfillment of Claiborne's purchase order and were overruns, irregulars, or stragglers, as described above.

 In April of 1993 a modification was made to Claiborne's practice to accept all excess goods. The modification consisted of the so-called "200-piece requirement" before any excess goods would be accepted. Claiborne concluded that the cost of processing small quantities of irregulars, less than 200 pieces, militated against acquiring these smaller amounts which would then be disposed of by the manufacturer as excess.

 Listanowsky, the originator of the 200-piece requirement, testified that it applied to Mademoiselle, testimony which was consistent with Mademoiselle's status as a major supplier. Claiborne's witnesses testified that the policy did not apply to Mademoiselle because Claiborne was financing Mademoiselle's yarn. However, no testimony was offered as to the mechanics of this financing to establish that Claiborne owned the yarn and therefore all the units. The testimony and the logic of the relationship established that the 200-piece requirement was applied to Mademoiselle although there is no direct written evidence on this issue, either way. Similarly, the 200-piece requirement to make any sense had to be, and was, applied to a particular style, not individual lots.

 Excess goods could be sold by Claiborne contractors as long as the Claiborne trademarks were protected by alteration of the identification of the goods and the timing of the sales. The contractor was required to (1) cut notches or mark the neck label (which bears the Claiborne trademarks), remove the hang-tags, and in the case of irregular goods, mark the goods as irregular; and (2) wait a period equal to six months after the in-store date ("waiting period").

 The waiting period prevents a contractor's discounted irregulars or overruns from being offered for sale at the same time first quality Claiborne goods are being offered for sale by Claiborne's customers or outlet stores. The Contractor's Manual refers to a waiting period of three seasons. At the time the Contractor's Manual was drafted, Claiborne had six selling seasons lasting two months each. Claiborne currently has four selling seasons lasting three months each. Whether couched as two or three selling seasons, the time period has remained consistent at six months and is a common industry standard. Listanowsky's testimony to the contrary was not credible.

 Newhouse testified that this policy concerning excess goods was modified early in November 1995 when Richard Owen ("Owen), a Claiborne Vice President of Manufacturing, advised him to sell all its excess inventory. Owen does not recall such an authorization, and there is no written evidence of such a change in policy, nor any explanation as to why such a change would be in Claiborne's interest.

 Mademoiselle has suggested that the Owen authorization is confirmed because thereafter Mademoiselle did not submit an excess offering to Claiborne, and this inaction was never questioned by Claiborne. However, excess garments were accepted by Claiborne in late November 1995, at the time of the alleged Owen authorization. Thus, there is a four-month span between the receipt of excess goods by Claiborne in late November 1995 and the filing of this action in late March 1996. A four-month span ...


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