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E.G.L. GEM LAB LTD. v. GEM QUALITY INSTITUTE

February 2, 2000

E.G.L. GEM LAB LTD., PLAINTIFF,
V.
GEM QUALITY INSTITUTE, INC. D/B/A EUROPEAN GEMOLOGICAL LABORATORY AND D/B/A EGL LOS ANGELES AND D/B/A EGL-LA, ET AL., DEFENDANTS.



The opinion of the court was delivered by: Lewis A. Kaplan, District Judge.

  OPINION

Brand names — trademarks — are pervasive in modern business. Frequently, however, the business carried out under those marks is conducted by licensees pursuant to relationships in which the licensee benefits from the goodwill and consumer recognition of the licensed trademark while the licensor benefits from the capital investment and entrepreneurial skills of the licensee. A licensee often faces substantial risks in such a relationship, especially the risk that the licensee's business will be so dependent upon the continued right to use the trademark that its very existence would be jeopardized by the expiration or termination of the license.*fn1 A rational licensee in such circumstances often will take steps to ensure the development of a business sufficiently independent of the licensed trademark to survive the end of the license. Whether the steps taken are consistent with the licensee's obligations to the licensor or trademark owner and to the consuming public, however, frequently present close questions of policy and fact. This case presents just such questions.

I

Plaintiff E.G.L. Gem Lab Ltd. ("EGL Ltd.") brought this action for trademark infringement and dilution, false designation of origin, unfair competition and breach of contract against Gem Quality Institute, Inc. ("GQI") d/b/a European Gemological Laboratory and d/b/a EGL LA, Independent Gemological Laboratory, Inc. ("IGL"), Guy Margel, Thomas E. Tashey, Jr. and Myriam Tashey. GQI and the Tasheys counterclaimed against EGL Ltd. and Nachum Krasnianski, president and sole shareholder of EGL Ltd., alleging fraud and intentional interference with business relations and cross-claimed against Margel. The issues relating to Margel were settled before trial and the counterclaims against EGL Ltd. and Krasnianski have been abandoned. Plaintiff has consented to the dismissal of the claim against IGL.*fn2 The remainder of the case was tried to the Court. The following are the Court's findings of fact and conclusions of law.

A. Gem Grading

This case involves the small and tight-knit business of gem grading — the classification of precious stones, generally diamonds, according to certain characteristics. Gem grading laboratories examine and rate stones and issue certificates setting forth their findings. Those dealing in stones rely on such certificates as verifications of quality and, at least indirectly, value. Gem grading laboratories thus provide independent assessments frequently used in what otherwise often would be ill-informed purchase and sale decisions.
Two sorts of gem grading are relevant to this case. Gem stones, particularly diamonds, are classified by cut, color, clarity and weight.*fn3 In addition, colored stones, including some diamonds, may be rated or graded with respect to color, although there are no universally accepted criteria for such color characterizations.*fn4

B. The EGL Network

There is only a handful of prominent gem grading businesses in the world. Among the two leaders is European Gemological Laboratories, or EGL,*fn5 which was founded by Guy Margel when he opened the first EGL laboratory in Antwerp, Belgium, in 1974.*fn6 He then expanded quickly, opening a second laboratory three years later in New York, a third in Los Angeles in 1978,*fn7 and others in Israel, France and South Africa soon thereafter.*fn8 In 1980, he obtained federal registrations of the trademarks "European Gemological Laboratory" and "E.G.L." in the name of European Gemological Laboratory, Inc. ("EGL Inc."), a New York corporation of which he was the sole shareholder.*fn9
The protagonists in the current dispute, Nachum Krasnianski and Thomas Tashey, Jr., both were employees of Margel's EGL operation. Krasnianski managed its New York laboratory. Tashey worked as a grader in the EGL Los Angeles laboratory for about fifteen months before leaving and, in 1980, starting his own Los Angeles operation with his wife, Myriam, under the name Independent Gem Lab.*fn10

1. Margel's Sale of the U.S. EGL Business

In the mid-1980's, amidst a downturn in the international diamond market, Margel found his gem grading laboratories in some financial difficulty and so decided to spin off his U.S. operations while attempting to keep the network he had built intact.

2. Margel's Sale to Krasnianski

In January 1986, EGL Inc. sold assets and its business to N.K. Gemological Services Inc., a company wholly owned by Krasnianski which thereupon changed its name to E.G.L. Gem Lab Ltd. ("EGL Ltd."), the plaintiff in this case. As part of the transaction, EGL Ltd. acquired all of the U.S. EGL marks and granted to Margel a "royalty free license to use the [EGL marks] in connection with the business of evaluating gems in the greater Los Angeles, California area."*fn11

3. The Sublicense to Tashey

At or about the same time, Margel began negotiations with Tashey to grant him a sublicense to use the EGL marks in Los Angeles in return for royalty payments. On February 7, 1986, Margel's counsel wrote to Tashey following a series of conversations. The letter confirmed that Tashey had been granted a license to use the EGL marks in the Los Angeles area, that Tashey would pay Margel a percentage of his gross income earned in connection with those marks, and that Tashey would "have no authority to do business in the name or on behalf of [EGL Inc.] or any other corporation of which Mr. Margel was or is a principal."*fn12 It asked that Tashey sign and return a copy of the letter to signify his agreement. Tashey responded by expressing concern about the prohibition of his doing business in the name or on behalf of EGL Inc.:*fn13
"The use of the name for our company in promotion and advertising is essential to its value. We do not intend to hold ourselves out as agents, officers, or representatives of your client or his businesses, corporate or otherwise.
"In a recent phone conversation with Mr. Margel, he specifically indicated to me that he wished us to use the name in our business in the same manner as if we were connected to the California corporation and to the larger `EGL family', rather than as a separate entity. We are attempting to comply with his requirements."*fn14

Margel's counsel promptly responded that Tashey's letter had captured the intentions of the parties.*fn15

Upon his receipt of that communication, Tashey signed and returned the initial letter.*fn16

Tashey portrays the agreement thus reached as having done no more than given Tashey the right to use the EGL name.*fn17 But he takes much too narrow a view, colored substantially by his present self interest. It was in the mutual interest of Margel and Tashey that Tashey's Los Angeles operation be viewed as part of the overall EGL operation, that it present itself to the public as before — as an EGL laboratory and part of the larger EGL network. As Margel testified, and as Tashey's own letter suggests, Margel told Tashey that he was to operate only under the EGL name, and Tashey agreed.*fn18 Hence, Tashey undertook to operate the Los Angeles laboratory under the EGL name just as if it "were connected to the California corporation and to the larger `EGL family', rather than as a separate entity."*fn19 His agreement to do so was a material part of Margel's inducement to grant the sublicense, as Margel intended the entire EGL network to continue to present itself as a single entity, despite the ownership changes in the United States, and he certainly would not have placed the EGL Los Angeles laboratory in the hands of a competitor. For a time, Tashey's Los Angeles operation was uncontroversial. In 1991, however, a dispute over royalty payments*fn20 led Tashey and Margel to renegotiate the 1986 sublicense.*fn21 The new agreement, which became effective on December 30, 1991, resolved the economic dispute and confirmed the terms of the 1986 agreement but added a number of additional provisions that are relevant here. First, it extended the term of Tashey's rights to December 31, 2001.*fn22 Second, it required Tashey to furnish Margel with samples of all promotional material, certificates, and other documents that used or referred to the EGL marks in any manner.*fn23 Finally, it proscribed any use of the EGL marks that would "impair or tend to impair [them] . . . or the business reputation and goodwill associated therewith."*fn24

The EGL business in the United States, to all outward appearances, continued as before for some time. As the foregoing indicates, however, the ownership situation actually was quite different. The U.S. business and marks were owned by Krasnianski's EGL Ltd. subject to the license for use of the marks in the Los Angeles area, which belonged to Tashey as a result of his sublicense from Margel. From an ownership perspective, Margel was out of the U.S. picture although he remained the licensee-sublicensor with respect to Los Angeles and retained the right to receive royalties from both Tashey and Krasnianski.

C. The Expansion of Tashey's Activities

Tashey proved an aggressive and effective operator of the EGL business in Los Angeles. By 1993 or 1994, however, it had dawned on Tashey that a potential problem loomed. He successfully had invested a great deal of effort in promoting the EGL marks in Los Angeles, but his right to use the EGL name and marks would expire, absent a new agreement, at the end of 2001. He therefore was subject to the risk that Margel would refuse to renew the sublicense and that Margel, Krasnianski or someone else would open a gem grading business in Los Angeles under the EGL name.*fn25

Recognizing that all his eggs were in a single, fragile basket, Tashey first approached Krasnianski in the hope of buying the EGL U.S. business or marks.*fn26 In a letter dated September 27, 1993, he wrote:

"Enclosed please find our two agreements made with Guy [Margel], along with your letter to Guy and the info we got from our lawyer concerning the EGL trademarks and their being `assigned' to you.
"Please do consider what you would want to assign them to us and let us know — no hurry. We will certainly respect your desire to keep them or the New York lab — we just wanted to start discussions, and we are very concerned with what to do with Guy & the Antwerp lab."*fn27

Krasnianski, however, rebuffed the overture.*fn28 So Tashey decided to build up a gem grading business of his own that could survive termination of the EGL sublicense.*fn29 And this presented an appreciable business problem. EGL was one of the handful of recognized grading laboratories in the world, and Tashey to that point was not well known in the trade except, perhaps, as the director of EGL's Los Angeles operation. As he admitted at trial, "it takes quite some time to establish identity, and it takes even more time to have people rely and depend upon a name and reputation of an entity in this type of business;"*fn30 being viewed as part of an international network of laboratories as opposed to a local laboratory is of substantial importance.*fn31 So Tashey — although he would have been free to terminate the EGL license and go into business for himself without the EGL marks*fn32 — instead decided to use the EGL marks to gain prominence and prestige for his own operation while at the same time paving the way for an eventual split between them.*fn33

1. Differentiation of EGL Los Angeles and Formation of GQI

An essential feature of the plan was the establishment of an identity for the Tasheys' operation distinct from the rest of EGL and thus able to continue following any expiration of the right to use the EGL name.

In July 1993, Tashey applied to the Patent and Trademark Office for registration of the mark "GQI," which was an acronym for Gem Quality Institute.*fn34 In January 1994, he and his wife formed a California corporation called Gem Quality Institute, Inc. ("GQI")*fn35 to serve as "the corporate parent" for the EGL laboratory in Los Angeles.*fn36 Tashey then began to use the name GQI prominently in a manner designed to associate GQI with EGL as the source of the services provided by the Tasheys' Los Angeles operation. He intended that the GQI mark initially would draw strength from the association with EGL and, by 2001, be sufficiently distinctive and well known to leave Tashey with a valuable business even if he lost the right to use the EGL marks.*fn37 Once GQI was formed, he pursued this goal by a number of related means.

2. Colored Stones

As noted above, there is no universally accepted system for grading color stones or, more precisely, the color characteristics of stones. Historically, EGL labs have issued reports characterizing the color of diamonds although there have been no generally accepted standards, even among EGL labs, for doing so.*fn38 Although the evidence is less clear, it appears that they have not "graded" other types of gem stones for color although they have done much the same thing but called the process "identification" rather than grading.*fn39

When Tashey took over the EGL Los Angeles laboratory upon his procurement of the sublicense from Margel, he began to issue reports on colored stones, including diamonds, under the EGL name, an activity he continued into 1994.*fn40 At or about that time, however, he began using a different method*fn41 for grading colored stones and began offering it only under the GQI name.*fn42 In a 1995 letter to clients, Tashey introduced the newly formed GQI as "the parent company of EGL-Los Angeles" and made clear that GQI — not EGL — would issue reports on colored stones, including diamonds.*fn43 Thus, while Tashey nominally continues to offer EGL colored stone identifications,*fn44 his promotional efforts with respect to colored stones have been devoted to GQI. Indeed, Tashey almost immediately began running advertisements for GQI's colored stone grading services under the headline, "Not Every Choice Is Black and White," which asserted that GQI had been created to fill a need for colored stone grading.*fn45 The logical inference, and the one drawn by the Court in the absence of credible evidence to the contrary,*fn46 is that Tashey's efforts have resulted in the diversion of substantially all colored stone grading work from EGL Los Angeles to GQI.

3. GQI Advertising and Promotion

The effort to capture EGL goodwill for GQI while at the same time differentiating GQI in a manner that would permit Tashey to benefit from the EGL association, even after expiration of their EGL license, is quite clear in Tashey's advertising and promotional efforts in and after 1994. Tashey advertised the GQI name extensively in printed media*fn47 and promotional letters to existing and potential customers,*fn48 by hosting receptions,*fn49 and by erecting a booth at trade shows marked prominently with the GQI name at which he graded stones and issued certificates under the EGL name.*fn50 In all of these endeavors, GQI was presented as closely affiliated with EGL. Several of the advertisements illustrate what Tashey was seeking to accomplish viz-a-viz the EGL and GQI marks.

At least one trade publication ad, not to mention a number of other promotional pieces, identified the Tashey operation as "Gem Quality Institute, Inc. d/b/a EGL-LA" and used both the GQI and EGL logos with equal prominence, albeit with the words "Los Angeles" beneath that of EGL.*fn51 These characterizations thus suggested, as Tashey plainly intended, that EGL-LA was a creature of GQI and, in consequence, that the EGL services and quality with which customers were familiar were products of the same management as those offered by GQI.*fn52 Moreover, while the phrase "EGL-Los Angeles" is readily distinguished from "EGL" in the searing spotlight of litigation, it is quite likely that the significance of the reference to Los Angeles was not understood by very many readers of these ads. Indeed, there is significant anecdotal evidence of confusion.*fn53 At least an appreciable number of readers of these publications were misled into believing that the EGL network as a whole was a GQI operation or, at least, an affiliate.

Tashey did not consistently present EGL as a GQI creation, however. On other occasions, he conveyed the thought that GQI and its colored stone activities were creatures of EGL certainly an understandable objective given EGL's prominence in the gem grading field. An advertisement Tashey first published in January 1994,*fn54 for example, stated: "E.G.L.-Los Angeles has created the Gem Quality Institute for your color stone grading needs. The same high quality services that you have grown to expect from E.G.L.-Los Angeles are the basis of this new and highly innovative company." Again, readers familiar with EGL, especially outside Los Angeles, were likely to believe that the EGL network was responsible for creating GQI, which of course was not so. Tashey took advantage of the confusion between EGL and GQI to promote the GQI operation at EGL's expense. Another advertisement that Tashey ran repeatedly from April 1995 through February 1998*fn55 portrayed GQI's colored stone services as an alternative to those offered under the EGL name. The headline read: "You Have More than One Choice." Beneath that legend appeared reprints of five advertisements or brochures of EGL and GQI.*fn56 Some of the reprints focused on diamond grading services of EGL Los Angeles or of EGL in general while the others dealt with the colored stone grading services of GQI. Beneath the reprints, the advertisement went on to state: "Two important services in one location that are changing the way the jewelry industry does business." This statement was flanked on one side by "E.G.L. Los Angeles" and the EGL logo and on the other by "Gem Quality Institute" and the GQI logo. Thus, Tashey used this advertisement to have GQI benefit from the association with EGL while at the same time establishing GQI as the source of a service — colored stone grading — different from the colored stone identification provided under the EGL name.
While Tashey's advertising was not always entirely consistent in its message concerning the precise nature of the claimed affiliation between EGL and GQI, some generalizations are clear. First, GQI almost always was presented as an affiliate of EGL in a clear effort to gain for GQI the identity and customer acceptance that EGL had built up over the years. Second, as Tashey admitted at trial, the degree of prominence that Tashey gave to GQI as compared to EGL in the advertising gradually increased over time.*fn57
Finally, the fig leaf upon which Tashey relied in doing so the references to "EGL-Los Angeles" rather than simply to "EGL" was ineffective. Customers and others in the trade for the most part either failed to notice the distinction or were confused by it. For example, customers mistakenly have sent payments to EGL-Los Angeles that were intended for EGL Ltd. in New York.*fn58

In 1997, EGL Ltd. was excluded as an exhibitor at the Southern Jewelry Travelers Association because GQI already had registered as EGL to exhibit there.*fn59 A Chicago real estate broker, upon hearing a rumor that EGL (i.e., Tashey) would open in that city, called Krasnianski to offer him space.*fn60 An Army acquaintance of Krasnianski told him that he had met Krasnianski's "boss," whom he understood to be Tashey's wife.*fn61 Indeed, the existence of extensive confusion in the trade is readily inferred from the fact that Tashey felt compelled to make a speech at a trade show to address what he characterized as "rumors about our name change" — a reference to the increasing frequency with which his operation was referred to as GQI.*fn62

4. Trade Shows

Trade shows also played an important role in Tashey's efforts. In 1994, he began providing EGL-branded on-site diamond grading services at trade shows outside of Los Angeles*fn63 from a trade show booth that prominently bore the GQI name.*fn64 By so doing, he enhanced industry recognition of GQI, promoted its association with EGL, and competed for diamond grading business under the EGL name in geographic areas in which Krasnianski's EGL Ltd. owned exclusive rights to the mark.

5. Other Activities

Tashey's efforts to create a separate identity, and to have GQI free-ride on the back of EGL, were not limited to his advertising. Over time, his price lists first displayed only the EGL name and marks, then both EGL and GQI, and ultimately only GQI.*fn65 He began affixing a hologram with the GQI mark alone to EGL certificates.*fn66
6. The Chicago Operation
In 1997, Tashey sought to increase his reach to Chicago. In April of that year, he and his wife signed a lease for office space in which to operate a gem grading laboratory under the name Gem Quality Institute, Inc. d/b/a European Gemological Laboratory.*fn67 When Margel declined to grant permission for use of the EGL marks in Chicago,*fn68 however, Tashey opened a full service laboratory solely under the GQI name. This was small comfort to Margel and Krasnianski for two reasons.

First, although the Chicago operation held itself out only as GQI, letters to customers and press releases referred to EGL or its Los Angeles "branch."*fn69 Tashey thus suggested an affiliation between EGL and the Chicago GQI business.

Second, they found that the Chicago operation was competing against EGL Ltd. Prior to the opening of the Chicago GQI laboratory, Tashey graded white diamonds only under the EGL name,*fn70 as Tashey understood that he was prohibited from such activity under any other name by the Margel agreement. Over 90 percent of GQI's business in Chicago, however, consists of grading white diamonds.*fn71 And Tashey conceded at trial that 30 to 40 percent of the Chicago business came from Los Angeles customers who presumably would have bought EGL certificates but for the availability of that service from GQI in Chicago.*fn72 Thus, a substantial part of the white diamond grading work previously done in Los Angeles under the EGL name has been shifted to GQI in Chicago. Moreover, there is credible evidence that at least some white diamond grading work has been diverted from EGL Ltd. in New York to the GQI Chicago operation.*fn73

7. Tashey's Intent

Thus, by 1998, Tashey had effectively used the EGL name to become a competitor under the GQI mark. He used the EGL name to establish GQI in the trade and to gain customer acceptance. He captured colored stone grading work in Los Angeles by presenting GQI as the EGL affiliate that performed that sort of work. He diverted white diamond grading business away from EGL to GQI's Chicago operation. He positioned himself to continue in the gem grading business after the expiration of the EGL ...

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