Taking the Design Piracy Debate to the Financial Industry

Panelists:
Philippe Faraut Managing Director, Financo Inc.
Dave Reza Senior Vice President Western Region, Milberg Factors Inc.
Ron Garber Executive Vice President, First Capital Western Region LLC
Bret Schuch Partner, Goodman Factors
Rob Greenspan Owner , Greenspan Consulting
Kevin Sullivan Executive Vice President, Wells Fargo Capital Finance
Nick Hart Regional Managing Director, Bibby USA
Ken Wengrod President,  FTC Financial Corp.
Don Nunnari Senior Vice President , Merchant Factors
Paul Zaffaroni Director of Investment Banking, Roth Capital Partners

Philippe Faraut: In Europe, designs are pro- tected. They are not here. At the end of the day, it’s not a bad thing to protect designs. Most other industries can protect their designs. It’s a little more complicated in apparel because it’s a lot more subjective and there are a lot more designs. I think it starts from the right point, so I think it’s a good idea. It’s all in the application of the law. In a lot of those situations, the only big win- ners are the lawyers. And, like everything

else in America, there’s going to be a lot of lawsuits over stuff. It’s just difficult to fore- cast how much it’s going to cost versus how much it’s going to benefit. Who it’s really going to hurt are some of the big retailers, the fast-fashion people. It might hurt them. At the end of the day, it’s going to be dif- ficult for the really small designers to pay the big lawyer fees [like] some of the big firms. That’s obviously a concern. It’s all in the execution. Remember, it’s the [Coun- cil of Fashion Designers of America] that started all this, and they seem to think that it protects the designers. I think it’s going to be difficult to enforce. In a way, every- body copies everybody. How do you prove somebody copied?

Ron Garber: I have not closely moni- tored this bill but have heard from several manufacturers, and they are all scared to death of passage. If they’re frightened, then, as a lender, it is of great concern to me, as well. What I’ve heard is the biggest fear is that some companies will become solely plaintiff litigants, ostensibly trying to enforce their perceived rights to designs and patterns that could go back decades. The retailer could react the way they did15 years ago during the Department of Labor’s crackdown on child-labor abuses in the apparel industry and withhold payments, thereby playing havoc with a lender’s primary repayment of collateralized loans. Hopefully, it won’t come to that, but we will be watching this issue much more closely in the near term.

Rob Greenspan: Yes, I have been following this major issue. And it is a difficult one. While designers need protection in the creative process, I don’t believe this is the right solu- tion. When legislation passes, there is always the chance of unintended consequences of the new law. In this case, in my opinion, the risks are too great with this bill. In particular, I am not certain if a judge, jury or any other lay- person really has the ability and knowledge to understand the design process and then make a determination that it has been violated. I am afraid of the lawsuits that could be filed and the interruption it could cause in one’s business. This could lead to many unwarranted lawsuits. Having banks and factors determining whether a manufacturer’s designs are original or not— because they own the related collateral, the accounts receivables and, maybe, the inven- tory—puts the factors and banks in an unfair position. At the end of the day, their job is to protect their collateral base. I personally don’t think any banker or factor wants to be in a position to have to make a decision about original designs. And while I haven’t talked to many factors or bankers about this, I would assume most would think they might not be qualified to do so. And if they did make that determina- tion, what would be their potential liability?

Nick Hart: It’s probably not too much of an issue for us. I think it has more impact on the large factors and the banks where the lending is, in part, brand lending. While it might not necessarily be a particular line of credit against the brand but part of the loan is the general UCC position that the lender is taking—the Uniform Commercial Code, that’s the security that they take behind the factoring agreement. It gives them a charge of collateral over all of the business, including the goodwill of the business.

If ever this becomes an issue, it’s likely to be with a big piece of business, where you have one large business effectively suing another large business—because that’s where the dol- lars are worthwhile, and you’re going to have fairly large lines of credit.

We tend to be quite transactional, in essence. We’re lending up to $5 million or so. At that level, it’s not too much of an issue for us. We’re more concerned with the performance and the integrity of the invoicing rather than the design integrity. Certainly, we’ve got some clients that are growing and will be big brands in the future. But the brand value is probably not at the level where it’s going to be too troubled by this, I suppose, unless we get a client that is fla- grantly ripping off a larger brand. We are much more invoice-based in terms of our lending.

The banks and the large factors sometimes take a broader view of all categories, and they may have some inventory lending and cash- flow lending, which will have more of an im- pact. It may well curtail some of the general re- volving lines of credit if an issue presents itself. It’s something we’ll keep an eye on.

We try to keep our business pretty simple. We don’t need to get too worried at this stage with contingent issues that may or may not arise in the future. If someone comes to us and

they’re already in some litigation, then that might start to impact us a little bit. But [it will depend on] how much it costs to defend one of these—especially if you have a big brand suing a relatively small client, a “David and Goliath” situation. Often it’s the legal fees that kill the thing. Because it’s cash flow, not profitability. If there is a pending lawsuit, it’s the cash flow that will probably kill the David rather than the Goliath.

Don Nunnari: Senate Bill 3728 was introduced to committee on Aug. 5. It has a long way to go to become law. The California Fashion Asso- ciation [recently] outlined 10 reasons why they believe this would be a bad law. I agree with most of their points. I’m confident that they are representing our industry and attempting to educate Sens. Boxer and Feinstein about the intricacies of the California apparel industry. Why change something that has been working for the past 100 years—particularly in these difficult economic times? We need less government interference, not legislation to protect a few high-end New York designers. Our business is concentrated in the apparel businesses, often investing in new designers and start-up companies. These often become large apparel companies in the future. Why limit or discourage this talent from developing? Why not invest more resources and award stiffer penalties on counterfeiters? You read all the time about Los Angeles–based True Religion defending itself against this criminal activity. Counterfeiters are the ones who are stealing money and jobs from legitimate companies who built a brand. Put the focus on curbing that criminal activity. Whether this law will “undermine” the collateral of banks and factors remains to be seen. I certainly hope banks and factors aren’t put in a position to determine if our client is a potential defendant in one of these cases. The expense of the bank or factor to acquire that expertise will be passed along to the manufacturer along with the legal expenses they would incur.

Dave Reza: Clearly, I don’t think any lend- er would want to be in a position where they would have to determine whether a product is original or not. We’re not conversant enough to know. If that became an issue, then I’m sure we would ask retail lawyers to advise us and to craft guidelines for determining certain aspects of the inventory’s originality or the design’s originality to comply with the law as well as to give us some framework for deciding whether we want to advance against that inventory or not.

I don’t think any factor is necessarily going to say we know who is doing knockoffs and who is not. But when you have a borrower that has gotten into a lot of lawsuits—for whatever the reason—it’s certainly a red flag.

Bret Schuch: While I understand the fash- ion industry’s desire for design protection, my concern is that government involvement may create a cure that’s worse than the illness. Ap- parel sales have been positively impacted by merchants’ ability to parlay current fashion- industry trends into affordable and fashion- able “one-off” options for less-affluent shop- pers. Forever 21 has built a virtual retail empire doing just that. There is also the argument that design emulation gives rise to more dynamic and fresh designs in order for the fashion houses to maintain offerings that are clearly current and unique. I’m wondering how many designs will ultimately become patent-protected, given the length of time this may begin to require. But at the end of the day, I seriously doubt that pas- sage of this bill will have that much effect on vendors or factors, but to the extent it does, it probably won’t be positive.

Kevin Sullivan: We have been following this issue closely and believe that it is absolutely a plausible consequence of the law if passed. While the intent of the legislation seems to be well-meaning, the reality of implementing this type of legis- lation is that it is very difficult to prove the originality of a given design in the apparel industry. We believe that it would force lenders to the apparel industry to become arbiters of fashion in determining whether a client’s designs were “different” enough from other designs already existing within the marketplace. While we support the protection of intellectual-property rights in general, this law would likely lead to a host of unintended consequences for the industry, not the least of which would be an increase in legal costs faced by apparel manufacturers.

Ken Wengrod: I feel there’s too much nega- tivism about this bill. People have become alarmist. I think most people are quoting the old DPPA and not the new IDPPPA, probably because they did not read it and compare. If they read through the IDPPA, they would see there are some real major improvements from the previous DPPA.

Everything I’ve read from the opponents of the bill is that the burden is on the defen- dant, but that’s not true. All the burden is on the plaintiff. After being renegotiated between the designers (CFDA) and the manufactur- ers (American Apparel & Footwear Asso- ciation), the bill became much narrower. The scope of what is protected now is very narrow and limited. What was designed prior to the bill becoming enacted will be in the public domain and not protected.

More people have to hear the positive side. This bill was intended to level the playing field and protect the designer. This is to protect the artistic form versus utilitarian articles. In my opinion, the bill is trying to protect the Davids or Danielles of the world, not the Goliaths or the people who knock off the artists. I don’t think it applies to too many people.

The beauty of this is that it gives the artist the ability to protect themselves. And they deserve it.

You have to read the new definition of what constitutes a copy in the bill. It is no longer “substantially similar,” as in the DPPA; it is now “substantially identical.” Remember, it’s not only a judge who is going to rule on this but also a jury—if it goes that far.

The young designer or young artist can file a pleading—on the first pass—even without an attorney. The judge will ask, “What proof do you, the plaintiff, have that you had it first and this was knocked off by the defendant?” Be- fore he/she gets a day in court, the plaintiff now must meet a high burden to prove his/her case in court—i.e., to plead the facts demonstrating: 1) that the plaintiff has a protected design, 2) that the defendant’s design infringes and 3) the plaintiff’s design was accessible to the defendant.

If the defendant keeps a record of [his or her] inspiration—especially if it was in the public domain prior to the law being enacted— that’s all [he or she] will have to show to be off the hook.

One change that I would make if I could would be on the legal side. I would make it even much stronger a protection for the young designer by making sure the prevailing party won’t be liable for attorney fees. Splitting legal fees doesn’t mean anything if it is David versus Goliath.

I think the bill has some great, interesting points. In Europe, this has been going on for a long time. The impact of that over there is that it acted as a deterrent. There are hardly any lawsuits. So that law is much more effective.

I wouldn’t overreact to the IDPPA security issue. It’s no different from a [textile] print. If you use a print that’s a knockoff, there’s a po- tential for getting sued even if you thought you bought it from an “open line.” It’s the same is- sue right now. Suppose you bought a print from a fabric converter or a mill and that’s someone else’s print? Do they lose the security interest? I wouldn’t necessarily be concerned with the lien side under the Uniform Commercial Code. It’s pretty far-fetched, and it would be against an individual item. In any case, the new bill protects people [acting] in good faith—whether manufacturers, distributors or retailers. And if they have the proper proof and they didn’t do anything wrong, then everything would be okay. I see a lot of benefits to help these young designers. In this environment, that’s the creative talent of our future of L.A.

Paul Zaffaroni: We have been following the Design Protection and Piracy Bill, given our in- volvement with the California Fashion Associa- tion and the consequences it could have for many of our clients. We appreciate the counterfeiting problem the luxury-goods industry faces today but think the “original design” issue at the heart of Senate Bill 3728 is too broad. Folks that we know in the factoring and banking community are not in a position to determine “originality” as it relates to the inventory (collateral) of their manufacturing clients. We hope a compromise can be reached on the new bill that meets the needs of both the premium designers and mod- erately priced manufacturers while not limiting their access to cost-effective financing. ●