Covenant not to sue divests trial court of jurisdiction over declaratory judgment counterclaims

The Nike Air Force I basketball shoe played a significant part in the promotion of hip hop music. The shoe was not only worn by many in the National Basketball Association, it was also a well-known 'street ball' shoe. The shoe was the subject of a 2007 Grammy-nominated single performed by hip hop stars such as Kanye West. In 2008 Nike obtained US Trademark Registration 3,451,905 for the design of the Air Force I shoe, including the stitching and panels.

Already LLC, d/b/a Yums, created and sells the 'Soulja Boy' shoe, which is directed to the hip hop market. Nike sued Yums, contending that the 'Soulja Boy' design infringed its trademark rights. Yums, in turn, filed a declaratory judgment counterclaim, alleging that Nike did not have valid trademark rights in the design and seeking to cancel the ‘905 registration under 15 USC §1119.

During discovery, Nike found a covenant not to sue that it had provided to Yums. The covenant stated that because Yums’ actions “no longer infringe or dilute the Nike mark..., [Nike] unconditionally and irrevocably covenants to refrain from making any claim(s)... based on the appearance of any of [Yums'] current and/or previous designs, and any colourable imitations thereof”. Nike thus moved to dismiss its own claims, with prejudice, and to dismiss Yums’ counterclaims, without prejudice. Yums objected to the dismissal of its counterclaims, claiming that it established a separate cause of action that survived any dismissal of Nike’s claims.

In order to maintain a declaratory judgment action, a party must demonstrate that there is an actual case or controversy between parties having adverse legal interests that is of sufficient immediacy and reality to warrant the issuance of a declaratory judgment. To demonstrate such a controversy, Yums filed affidavits from prospective investors who suggested that Nike’s lawsuit had deterred them from investing in Yums or had prompted them to withdraw prior investments. A former investor in Yums, for example, stated that he resold his stock to Yums at a loss after learning of Nike’s lawsuit, which he feared would tarnish Yums reputation and deter others from investing. The investor explained that, from his perspective, the covenant did not provide adequate assurance that Nike would not assert its trademark rights in the future against shoes similar to the Air Force I.

The US Court of Appeals for the Second Circuit ruled that, to determine whether a covenant not to sue eliminates the case or controversy requirement in a trademark action, courts must look at:

“ (1) the language of the covenant, (2) whether the covenant covers future, as well as past, activity and products, and (3) evidence of intention or lack of intention, on the part of the party asserting jurisdiction, to engage in new activity or to develop new potentially infringing products that arguably are not covered by the covenant.”

The Second Circuit found that the breadth of the covenant, including that it covered “colourable imitations” that would effectively be made in the future, rendered the threat of litigation over future designs remote or non-existent. The Second Circuit also found that potential investor's concerns about trademark infringement lawsuits did not establish the sort of genuinely adverse legal interests required to maintain a declaratory judgment action. Further, the court agreed with other regional circuits that a claim for cancellation of a registration under 15 USC §1119 does not create an independent basis for jurisdiction.

The Second Circuit thus dismissed Yums' counterclaims, without prejudice, and held that Yums’ cancellation claim would have to be lodged with the US Patent and Trademark Office.