Hill Design v . Hodgdon, et a l . CV-03-074-M 07/09/03 UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Hill Design, Inc.

v. Civil N o . 03-074-M O p . N o .

Vivian Hodgdon, et a l .

REPORT AND RECOMMENDATION

This Court issued a Report and Recommendation in the above-

captioned matter on April 7 , 2003 recommending that the

Plaintiff’s request for a preliminary injunction be granted in

part and denied in part (hereinafter “April 7th Report”).

Plaintiff filed an objection. By order dated May 2 7 , 2003, the

district court (McAuliffe, J.) declined to accept this Court’s

recommendation, and “recommitted the matter for reconsideration

of the first sale doctrine in light of the relevant facts”

(hereinafter “May 27th Order”). After reconsidering the evidence

in the record, it is the opinion of this Court that

(a) is applicable to the copies of BROWN BAG items sold by the

Defendants. In addition, it is the recommendation of this Court

that the district court use its equitable powers sparingly in

this case because the evidence shows that the Plaintiff has

unclean hands. BACKGROUND

The findings of fact in the April 7th Report are not

restated in their entirety here. Rather, the Court seeks to

clarify certain of its findings in light of the May 27th Order.

I. Agreement Between The Natkiels And Hodgdon

During the course of the hearing and in its objection to the

Report and Recommendation, counsel attempted to portray the

relationship in which M s . Hodgdon operated as “Art In Cooking” as

one between her and Hill Design, Inc. (“HDI”). While counsel’s

efforts to establish this “spin” at the hearing may be

legitimate, the effort to do so in the objection i s , at best,

misleading and, at worst, an intentional lack of candor to the

court. I did not find such a relationship nor is one supported

by the credible evidence.

In the fall of 2001 Plaintiff was essentially bankrupt. It

had not produced product at its old Hill, New Hampshire site for

years. It laid off its workers, closed its office and warehouse

and ceased production at its Concord facility in October of 2001.

Except to fill a few orders and to arrange a “straw” sale of

items to Mrs. Natkiel’s sister Helen Ross (at a bargain price in

light of the Natkiels’ later claims of value), Plaintiff ceased

2 to exist as an operating entity through at least the spring of

2002.

The only reasonable inference to be drawn is that the straw

sale was to divert HDI product from its liquidating creditors to

the benefit of the Natkiels. What was left of HDI property not

in the hands of the Natkiels was auctioned off by a bank

creditor, including product, product labels and equipment. From

that moment, M r . and Mrs. Natkiel, who owned and controlled H D I ,

treated it as defunct. They acted as though they personally had

all rights to direct the sale of the Ross inventory, to license

the HDI intellectual property and to authorize use of HDI’s Hill

facilities.

Exhibit 2 3 , from M r . Natkiel’s hand, is telling. The

Natkiels, not H D I , purported to license the HDI intellectual

property.1 The Natkiels, not H D I , were to be paid royalties.

The Helen Ross inventory was turned over to Hodgdon by the

Natkiels who said they were fully authorized to do it. 2 The

Natkiels made the HDI facilities available to Hodgdon free of

1 HDI is never even mentioned in the agreement. 2 When defendant Carpenter approached M r . Natkiel to buy $500.00 of the Ross inventory, he told her to complete the sale and pay Hodgdon who was authorized to sell for Art In Cooking.

3 charge through 12/31/04. While this agreement did not get signed

there was part performance under i t . M s . Hodgdon, clearly an

unsophisticated and inexperienced person in the business world,

was used and abused by the Natkiels, particularly M r . Natkiel, a

self-acknowledged sophisticated business man.

The Natkiels agreed to train Hodgdon in the mixing of clay,

pouring and casting, and finishing of cookie molds in

contemplation of Hodgdon opening up her own production and

distribution business for BROWN BAG products. April 7th Report

at 5-7. I repeat, the evidence does not demonstrate that the

Plaintiff, Hill Design, Inc., had a business deal or business

negotiations with the Defendants. Rather, the evidence showed

that Paul and Lucy Natkiel, in their individual capacities,

purported to have the authority to grant Hodgdon a license to

make and to distribute BROWN BAG items. See April 7th Report at

7 n.3; see also, P l . Ex. 2 3 ; D f . Ex. H , I .

In exchange for the Natkiels’ agreement to permit Hodgdon to

use the Hill facility and to provide Hodgdon training, Hodgdon

agreed to expend her labor and to commit her financial resources

to the manufacture and distribution of BROWN BAG items. Hodgdon

agreed to pay the Natkiels royalties based on her sales.

4 II. Categories Of BROWN BAG Items Hodgdon Sold

This Court found from the evidence that Hodgdon sold three

categories of BROWN BAG items after her business relationship

with the Natkiels ended: (1) items from her personal collection

of BROWN BAG products acquired while she was an HDI employee; (2)

items Hodgdon made at the Hill facility; and (3) items from the

“Helen Ross Inventory.” See April 7th Report at 1 4 . Plaintiff

makes no copyright or trademark infringement claims based on the

items in the first category, other than claims for Lanham Act §

43(a)(1) violations for false and misleading labeling. See P l .

O b j . to Rep. & Recomm. at 3 n.2. The Court does not find that

from the evidence that Hodgdon applied false and misleading

labels to the items from her personal collection.

Plaintiff stated in its objection to the April 7th Report

that this Court determined that the second category of BROWN BAG

items that Hodgdon sold included “copies Hodgdon made under HDI’s

supervision, control, and training, and using HDI’s raw

materials, production pouring molds, equipment, and facilities,

while “negotiating” a license with it (the “HDI Inventory”).”

P l . O b j . to Rep. & Recomm. at 3 . This Court made no such

finding. The Court rejects the “HDI Inventory” label for the

5 following reasons: (1) the Court did not find that Plaintiff was

a party to the oral agreement or business negotiations with

Hodgdon; and (2) the Court accepts as more credible Hodgdon’s

testimony that she primarily taught herself to fire molds, paid

for the utilities and raw materials at the Hill facility, and

supplied the labor to manufacture BROWN BAG items.

Adopting the label used erroneously and improperly by the

Plaintiff, the district court observed that “there are any number

of ways in which Hodgdon could have made the items in the HDI

inventory, without obtaining legal ownership of them.” May 27th

Order at 8 . This Court finds from the evidence that the only

BROWN BAG items that Hodgdon made were lawfully made at the Hill

facility under agreement with the Natkiels, by M s . Hodgdon, from

materials she owned and with resources she was lawfully using.

The actual legal ownership of those material objects vested in

Hodgdon.

III. Defendants’ Sales Of BROWN BAG Items After April 1 1 , 2002

In the April 7th Report, the Court recounted Hodgdon’s

testimony that on the morning of April 1 1 , 2002, Hodgdon’s

attorney told her that Lucy Natkiel had “pulled the rug” on the

deal. See April 7th Report at 8 . Later in the report, the Court

6 recounted Hodgdon’s testimony that it was her belief, after her

conversation with Lucy Natkiel, that the business deal with the

Natkiels had been put on hold pending completion of Plaintiff’s

settlement with its creditor. See April 7th Report at 1 3 .

Hodgdon testified that while her attorney had told her that the

deal was off, Lucy Natkiel did not.

It is undisputed that Hodgdon did not seek permission from

the Natkiels prior to removing items from the Hill facility.

Helen Ross and unspecified attorneys subsequently contacted

Hodgdon demanding that she return the items that she took.

Hodgdon testified that she prepared a handwritten inventory and

returned certain items on or about May 6, 2002. Hodgdon

testified that she only intentionally retained items that she

purchased for her company, items that she produced at the Hill

facility with her own labor and at her own expense, and items

from the Helen Ross Inventory that she needed to fill pending

orders. Hodgdon testified that she continued to fill pending

orders that were placed with her by former customers of HDI after

April 1 1 , 2002 because Paul Natkiel had arranged these sales and

had promised those customers prior to that date that Hodgdon

would fulfill their orders.

7 DISCUSSION

I. Application Of The First Sale Doctrine

The district court found that this Court’s failure to find

that Defendants Vivian Hodgdon and Art In Cooking, Inc. had any

right to take and sell the items in Helen Ross Inventory

necessarily rendered the first sale doctrine inapplicable with

respect to Hodgdon’s distribution of those items. See May 27th

Order at 6-7. This misapplication of the law was properly

corrected. The district court further found that the first sale

doctrine is inapplicable to the “HDI Inventory” absent a finding

that the Defendants had actual legal ownership of those items.

Id. at 8 . The district court requested that this Court make

findings regarding whether and how Hodgdon’s authorization under

an oral license was affected by HDI’s (actually the Natkiels’)

April 1 1 , 2002 decision to “pull the rug” on the deal with

Hodgdon.

With the exception of the BROWN BAG items from the Helen

Ross Inventory, this Court finds that Hodgdon was the lawful

owner of the BROWN BAG items that she sold after April 1 1 , 2002.

The Court finds from the evidence that the BROWN BAG items that

Hodgdon made at the Hill facility were lawfully made under

8 agreement with the Natkiels, and that the Natkiels’ decision to

“pull the rug” on the deal with Hodgdon did not cause ownership

of the material objects that Hodgdon made to revert to the

Natkiels or to the Plaintiff.3 Plaintiff’s ownership of the

copyrights at issue is distinct from ownership of the material

objects embodying the copyright. See

. The cases

cited by the Plaintiff in its objection, where courts enjoined

the post-termination use of trademarks by former licensees, are

inapposite. See P l . O b j . to Rep. & Recomm. at 1 0 .

While a copyright owner has the exclusive right to

distribute and to authorize distribution of copies of the

copyrighted work under the Copyright Act, “[n]otwithstanding the

provisions of section 106(3), the owner of a particular copy or

phonorecord lawfully made under this title, or any person

authorized by such owner, is entitled, without the authority of

the copyright right owner, to sell or otherwise dispose of that

copy or phonorecord.”

(a); Precious Moments, Inc.

v . La Infantil, Inc.,

6 , 67 (D. Puerto Rico 1997).

As Plaintiff acknowledges in its objection, free alienation of

3 Defendants have not contended that Hodgdon’s ownership of the BROWN BAG items that Hodgdon made at the Hill facility carried with it a transfer of the copyright. Cf., Forward v . Thorogood,

8 2 , 784 n.3 (D. Mass. 1991).

9 copies is permitted where the particular copy was lawfully made

or acquired. See P l . O b j . to Rep. & Recomm. at 6. The evidence

shows that Hodgdon’s copies were lawfully made and acquired under

Hodgdon’s oral agreement with the Natkiels.

An analogous set of circumstances to the facts in the

instant case appears in Bourne v . Walt Disney Company,

(2d Cir. 1995). In Bourne, the plaintiff contended that

although the defendant had a license to use the plaintiff’s

copyrighted compositions “in synchronism with any and all of the

motion pictures which may be made by [Disney],” nonetheless these

rights did not permit Disney to distribute the compositions on

videocassettes.

. The plaintiff argued that even if

the defendant lawfully possessed the videocassettes at issue, the

defendant had not acquired those cassettes as the result of a

“first sale” by the plaintiff, and therefore the first sale

doctrine could not apply.

. The court rejected the

plaintiff’s argument. The court found that because the defendant

had been licensed by the plaintiff to exploit the copyrighted

compositions in connection with its motion pictures, the

defendant should not be barred from being able to dispose of the

lawfully made copies.

10 Similar to the facts in Bourne, the evidence in the instant

case supports a finding that the BROWN BAG copies that Hodgdon

made were lawfully made and owned by Hodgdon. Hodgdon agreed to

pay the Natkiels a royalty based on her sales of those particular

BROWN BAG copies. Although Hodgdon did not acquire the copies as

the result of a “first sale,” Hodgdon was still entitled to sell

or otherwise dispose of those copies, even after the Natkiels

decided to “pull the rug” on the licensing deal that they were

negotiating. This Court finds that

(a) is

potentially applicable if Hodgdon’s version of the facts is

credited. Accordingly, this Court finds that the Plaintiff has

not demonstrated that the Defendants’ distribution of the BROWN

BAG items that Hodgdon made lawfully at the Hill facility

constituted copyright infringement under

(a).

II. Pervasive Evidence Of Unclean Hands

Plaintiff contends that this action arises out of the

Defendants’ scheme to sell infringing and unlawfully obtained

BROWN BAG items. In contrast, Hodgdon contended at the

injunction hearing that this lawsuit is in fact an offshoot of

the Natkiels’ scheme to use Hodgdon and her company to defraud

the Plaintiff’s creditor. Hodgdon contends that her relationship

11 with the Natkiels broke down only because Hodgdon’s attorney

sought to protect Hodgdon’s interests with respect to Hodgdon’s

use of the Plaintiff’s intellectual property. This Court finds

from the current state of the record that Hodgdon’s version of

the facts is on the whole more credible. Because the evidence

suggests to this Court that the Plaintiff has come to court

seeking equitable relief with unclean hands, this Court

recommends that any preliminary injunctive relief granted to the

Plaintiff be limited.

The district court has wide discretion in deciding whether

to deny a plaintiff’s request for equitable relief based upon a

plaintiff’s alleged unclean hands. Donoghue v . IBC USA

(Publ’ns), Inc.,

(1st Cir. 1995); Texaco

Puerto Rico, Inc. v . Dep’t of Consumer Affairs,

6 7 , 880

(1st Cir. 1995) (“It is old hat that a court called upon to do

equity should always consider whether the petitioning party has

acted in bad faith or with unclean hands.”). The Supreme Court

has explained that the doctrine of unclean hands “closes the

doors of a court of equity to one tainted with inequitableness or

bad faith relative to the matter in which he seeks relief,

however improper may have been the behavior of the defendant.”

12 Precision Instrument Mfg. C o . v . Auto. Maint. Mach. Co.,

(1945). It is the opinion of this Court that the

doctrine of unclean hands is properly invoked based upon the

evidence in the record.

The evidence showed that the Plaintiff was in serious

financial difficulty, with its assets subject to a creditor’s

lien, when it closed its Concord facility and liquidated its

inventory. Paul Natkiel, a sophisticated businessman, encouraged

Hodgdon, who had been laid off by the Plaintiff, to start a

business making and selling the Plaintiff’s copyrighted items

while the Plaintiff was essentially defunct. At the relevant

time, Hodgdon was comparatively unsophisticated in business

matters, but was devoted to the Plaintiff’s BROWN BAG line.

Before being laid off, Hodgdon assembled a collection of

items in the Concord inventory that she thought could save the

Plaintiff’s BROWN BAG line. Hodgdon later requested to buy these

items prior to the liquidation of the Plaintiff’s inventory.

While denying Hodgdon’s request, the Plaintiff purportedly sold

them to Lucy Natkiel’s sister, Helen Ross, for $5,000.4 D f . Ex.

4 A review of Paul Natkiel’s testimony suggests that Helen Ross was merely a straw purchaser. Paul Natkiel testified that after his initial conversations with Hodgdon about saving the BROWN BAG line, he realized that “[t]he very first step would be

13 A. This sale took place within two weeks of the auction of the

Plaintiff’s Concord inventory to satisfy obligations to its

creditor. Plaintiff directed Hodgdon and others to store those

items in trailers at the Hill facility. Paul Natkiel encouraged

Hodgdon to sell the inventory and directed former HDI customers

to Hodgdon for order fulfillment.

Despite having sold the Helen Ross Inventory for $5,000,

Plaintiff alleges in this lawsuit that the value of that

inventory was almost $48,000. See Ver. Compl. at ¶ 3 6 . The

estimated value of the inventory increases further still at other

places in the record. In the license agreement drafted by Paul

Natkiel, the agreement provided that Hodgdon was to credit Helen

Ross for the beginning product inventory and to carry that

inventory on her company’s books “for an amount not to exceed

$60,000.” See P l . Ex. 23 at 3 . Paul Natkiel represented to

Defendant Pat Carpenter that Hodgdon’s company owned the Helen

Ross Inventory and that there was an amount sufficient to serve

to secure part of the inventory out of the liquidation so that we would have a place to start.” He went on to testify that Hodgdon suggested the inventory that might be of value, and then “[w]e negotiated with the bank and purchased part of that inventory and it was moved to Hill . . . .” Neither Helen Ross, nor any representative from Cookie Art Exchange, the entity for whom the inventory was purportedly held, testified at the injunction hearing. See D f . Ex. A .

14 as collateral for Carpenter’s potential $100,000 investment. See

April 7th Report at 11-12.

Plaintiff further alleges in the Verified Complaint that

Hodgdon breached an agreement to repay a loan by the Natkiels of

$5,175.64.5 See Ver. Compl. at ¶¶ 69-72. Hodgdon testified that

Paul Natkiel signed over to her checks written to the Plaintiff,

during the time that the Plaintiff was still in negotiations with

its creditor. Hodgdon contends that these checks were signed

over to her to cover severance pay owed to her. See D f . Ex. O .

Hodgdon contends that she spent this money on equipment and raw

materials for her business. For example, Hodgdon testified that

Paul Natkiel harangued her into purchasing kilns. See D f . Ex. B .

Hodgdon testified that as of the date of the injunction hearing,

she had never used those kilns.

While the evidence shows that the Plaintiff is the only

named owner of the federal copyright and trademark registrations

at issue in this lawsuit (see P l . Ex. 1 - 2 ) , the draft license

agreement shows that the Natkiels treated the Plaintiff as their

alter ego. Unbeknownst to Plaintiff’s creditors, the Natkiels

purported to have the authority, in their individual capacities,

5 Even if this allegation were true, the claim would belong to the Natkiels not the Plaintiff.

15 to grant Hodgdon a license to make, purchase or market current or

future BROWN BAG items. See P l . Ex. 23 at 1 . The Court finds

that the Natkiels did grant Hodgdon an oral license to the

Plaintiff’s intellectual property until April 1 1 , 2002, a finding

the Plaintiff has not disputed.

Having encouraged Hodgdon to start a business with the

express purpose of making and distributing BROWN BAG items, the

evidence shows that the Natkiels discouraged Hodgdon’s efforts to

ensure that her company could use the Plaintiff’s intellectual

property without objection or exposure to claims by the

Plaintiff’s creditor. Lucy Natkiel testified that when the

Natkiels began negotiations with Hodgdon, the Plaintiff’s

creditor had not chosen to exercise its rights against the

Plaintiff’s copyrights. See April 7th Report at 8-9. The

Natkiels did not want the creditor to believe that the

Plaintiff’s copyrights had value for fear that the information

would cause the creditor to seek more money in a settlement.

The evidence suggests that the relationship between the

Natkiels and Hodgdon began to unravel after Paul Natkiel

solicited Pat Carpenter’s investment in Hodgdon’s business.

Carpenter testified that she made arrangements to transfer money

16 for her investment in Hodgdon’s business, but became nervous

about the Natkiels’ inability to produce a contract, and about

the Natkiels’ unresolved negotiations with the Plaintiff’s

creditor. Carpenter testified that she then became nervous for

Hodgdon, and the possible loss that she might experience, as a

result of all of the time and money that Hodgdon had been

spending on her business. Carpenter recommended to Hodgdon that

she contact an attorney, which she did. The evidence showed that

Lucy Natkiel decided to “pull the rug” on the deal after having

an argument with Hodgdon’s attorney.

In light of all of the facts recited above, this Court finds

from the evidence that the Natkiels used Hodgdon to exploit a

valuable part of the Plaintiff’s then former business while at

the same time keeping assets away from Plaintiff’s creditor.

Now, in the face of the Natkiels’ encouragement to Hodgdon to

start a business making and distributing BROWN BAG items, and

Paul Natkiel’s promises to customers that Hodgdon would fulfill

their orders, the Plaintiff seeks equitable relief from the court

that could leave Hodgdon in the lurch, potentially responsible

for breach of contracts entered into at Paul Natkiel’s behest.

If HDI had a role it was by and through its then stockholders and

17 officers, the Natkiels. This Court finds that the Plaintiff is

tainted by the Natkiels’ unclean hands with respect to the claims

before this Court. Therefore, this Court recommends that any

equitable relief granted to Plaintiff be limited. Donoghue,

; Texaco Puerto Rico,

6 7 , 880 (1st Cir.

1995). In particular, this Court recommends that the Defendants

not be enjoined from selling items from the Helen Ross Inventory

to fill outstanding contracts pre-dating April 1 1 , 2002, or BROWN

BAG items that Hodgdon made lawfully at the Hill facility under

an oral agreement with the Natkiels.

Any objections to this Report and Recommendation must be

filed within ten (10) days of receipt of this notice. Failure to

file objections within the specified time waives the right to

appeal the district court’s order. See Unauthorized Practice of

Law Committee v . Gordon,

1 , 13-14 (1st Cir. 1992);

United States v . Valencia-Copete,

, 6 (1st Cir. 1986).

James R. Muirhead United States Magistrate Judge Date: July 9, 2003 cc: David P. Eby, Esq. Garfield B . Goodrum, Jr., Esq. Vivian Hodgdon, pro se Edmund J. Waters, Jr., Esq.

18