Opinion ID: 660173
Heading Depth: 2
Heading Rank: 4

Heading: Tax Expense

Text: 26 In its March 10, 1992 damages opinion the district judge refused to deduct taxes K-Mart paid on income from sales of the Damask sweaters, which the retailer estimated as 42.94 percent of its income. K-Mart avers this refusal was error because as a nonwillful infringer, K-Mart may reduce gross profits through a legitimate deduction for income taxes and thereby pay an after-tax damage award to Hukafit. 27 It is settled law that the income tax paid on profits is not deductible where infringement was conscious and deliberate. See L.P. Larson, Jr., Co. v. Wm. Wrigley, Jr., Co., 277 U.S. 97, 48 S.Ct. 449, 72 L.Ed. 800 (1928); Alfred Bell & Co. v. Catalda Fine Arts, Inc., 191 F.2d 99, 106 (2d Cir.1951); Sheldon v. Metro-Goldwyn Pictures Corp., 106 F.2d at 53. In Larson, a case of a willful infringer, the Supreme Court held that the defendant could not deduct federal income and excess profits taxes from its gross income in determining the net profit for which it was liable. 277 U.S. 97, 99-100, 48 S.Ct. 449. But the Court carefully limited the breadth of its holding recognizing that there could be cases where the circumstances of the infringer's conduct dictated that such a tax deduction would be proper. See id. 28 In Stromberg Motor Devices Co. v. Detroit Trust Co., 44 F.2d 958, 965 (7th Cir.1930), a patent infringement case, the Seventh Circuit interpreted Larson 's caveat to stand for the proposition that in the case of a nonwillful infringer, such an income tax deduction would be appropriate. In Stromberg Motor Devices Co. v. Zenith-Detroit Corp., 73 F.2d 62, 65 (2d Cir.1934), cert. dismissed, 294 U.S. 735, 55 S.Ct. 509, 79 L.Ed. 1263 (1935), citing both Larson and Stromberg Motor Devices Co. v. Detroit Trust Co., we ruled that in the case of a nonwillful patent infringer an income tax deduction would be appropriate. 29 In Alfred Bell & Co. v. Catalda Fine Arts, Inc., we were called upon to decide the same issue already decided in the patent infringement context in a copyright case. The district court interpreted Larson as we had in Stromberg Motor Devices, and found Catalda was not a willful infringer, and that it thus was entitled to an income tax deduction. See 86 F.Supp. 399, 418-19 (S.D.N.Y.1949). On appeal, we agreed with the district court's view of the law but rejected its finding of innocent infringement, noting that [o]pen and unabashed piracy is not a mark of good faith and that in [those] circumstances  it was not proper to deduct taxes. See Alfred Bell, 191 F.2d at 106 (emphasis supplied). 30 A similar result was reached in another copyright case, where the district court allowed a credit for income taxes paid. See Sheldon v. Metro-Goldwyn Pictures Corp., 26 F.Supp. 134, 142 (S.D.N.Y.1938). Again, on appeal we recognized the Stromberg Motor Devices case as authoritative precedent, but reversed the district court because it erred in finding the defendants were not deliberate plagiarists. See Sheldon, 106 F.2d at 53. 31 The district court's reliance on Love v. Kwitny is misplaced. It was an appeal from the district court that was affirmed without opinion and therefore not binding precedent. See 2d Cir. R. 0.23. In disallowing deductions for taxes regardless of innocence, Love relied on Schnadig Corp. v. Gaines Mfg. Co., 620 F.2d 1166, 1169-71 (6th Cir.1980), and declined to follow Stromberg Motor Devices, Alfred Bell and Sheldon, which are controlling precedents, wrongly dismissing their statements as dicta because of the ultimate results those cases reached. See Love, 772 F.Supp. at 1371. Schnadig purports to illustrate hypothetically how an infringer in a patent infringement case who pays damages based on after-tax profits and takes an income tax deduction as allowed under the Internal Revenue Code, 26 U.S.C. Sec. 162 (1988 & Supp. III 1991), in the amount it paid to a patentee would, in the example the court uses, yield a net gain, leaving it in about the same position as the patent holder. See 620 F.2d at 1169. 32 We think that when a claim is made for infringing profits, [t]his means profits actually made. A book profit of a dollar is not a profit actually made when from the dollar the government takes twenty cents as the price for the right to make any profit at all. Macbeth-Evans Glass Co. v. L.E. Smith Glass Co., 23 F.2d 459, 463 (3d Cir.1927). Hypothetical discussions of possible indirect tax ramifications do not change this basic fact. In appropriate cases therefore we include income tax expenses in the deductible overhead in determining a defendant's net profit. See, e.g., Murphy Door Bed Co. v. Interior Sleep Sys. Inc., 874 F.2d 95, 103 (2d Cir.1989). Because the district court found K-Mart to be a nonwillful infringer, it should have allowed K-Mart a deduction for the taxes it paid on its innocently-acquired unlawful profits. II Attorneys' Fees 33 Upon reconsidering the damages issue, the district court in a second opinion reversed its earlier refusal to award Hukafit attorneys' fees. It agreed with Hukafit that attorneys' fees are normally granted to prevailing copyright plaintiffs as a matter of course, and that the indemnity relationship between K-Mart and third-party defendant Selective made K-Mart responsible for the introduction of bogus defenses that protracted the case to the severe detriment of Hukafit. It then awarded Hukafit a modest fee of $150,000. 34 The Copyright Act states that in its discretion a court may award a reasonable attorney's fee to the prevailing party. 17 U.S.C. Sec. 505 (1988). A distinction is drawn between prevailing plaintiffs and defendants in copyright actions. We agree that attorneys' fees are awarded to prevailing plaintiffs as a matter of course. See, e.g., Folio Impressions, Inc. v. Byer Cal., 937 F.2d 759, 767 (2d Cir.1991); Whimsicality, Inc. v. Rubie's Costume Co., 891 F.2d 452, 457 (2d Cir.1989). But prevailing defendants are awarded attorneys' fees only where the plaintiff's suit was brought in bad faith or was a baseless or frivolous action. See, e.g., Roth v. Pritikin, 787 F.2d 54, 57 (2d Cir.1986). The different treatment of successful plaintiffs from defendants is based on the purpose of the Copyright Act, which is designed to encourage plaintiffs to act to protect their copyrights. See, e.g., Diamond v. Am-Law Publishing Corp., 745 F.2d 142, 148 (2d Cir.1984). Awards of attorneys' fees to defendants are granted more sparingly to serve the same purpose, that is, that plaintiffs not be chilled in exercising their rights under the Copyright Act. See, e.g., Roth, 787 F.2d at 57. 35 We reverse an award of attorneys' fees only if we believe the district court has abused its discretion. Twin Peaks Prods., Inc. v. Publications Int'l, Ltd., 996 F.2d 1366, 1383 (2d Cir.1993). K-Mart argues that the district court's reversing itself on the attorneys' fees issue without changing its original finding that K-Mart was not a willful infringer is an abuse of its discretion. The cornerstone of this argument rests on the proposition that attorneys' fees may not be awarded against a defendant who is an innocent infringer. 36 An award of attorneys' fees has the consequential effect of penalizing the losing party. An award's primary purpose is, as already stated, to serve as an economic incentive for a copyright holder to use the courts in challenging an infringement. See, e.g., Oboler v. Goldin, 714 F.2d 211, 213 (2d Cir.1983) (per curiam). The fact that a defendant has been held liable for infringement necessarily means the defendant is blameworthy. See Nimmer & Nimmer, supra, Sec. 14.10[D], at 14-126. Willful infringement therefore is not a necessary requirement for an award of attorneys' fees to a prevailing plaintiff. An award to prevailing plaintiffs nonetheless remains discretionary with the trial court. 37 K-Mart correctly points out that the district court never altered its original finding that it was not a willful infringer because it relied in good faith on the advice of counsel that no infringement had taken place. The trial court made this finding in its March 10, 1992 opinion after a detailed look at K-Mart's response to Hukafit's infringement notice. As related, K-Mart immediately hired expert copyright counsel who contacted Hukafit's attorney and investigated the infringement claim. This investigation revealed that Selective, the sweater supplier, possessed a receipt for a sweater it purchased in Israel that was used as a pattern for the K-Mart sweaters. Thus, in counsel's view, any copying of Hukafit's copyrighted design was disproved. K-Mart shared this information with Hukafit's counsel at a November 1991 meeting. After learning of it, Hukafit's counsel declined to move in district court for a preliminary injunction to halt the sale of the K-Mart sweaters, in part because counsel did not believe that he could show the required element of likelihood of success on the merits. 38 On reconsideration, the district court vacated its earlier analysis on the revised finding that K-Mart should be held accountable for the litigation tactics of Selective, the third-party defendant. Characterizing Selective as K-Mart's partner and collaborator in the injury to Hukafit's rights, the district court agreed with Hukafit that bogus defenses were raised by Selective on behalf of and for the benefit of K-Mart, its indemnitee, that it was K-Mart that brought Selective into the case, and that K-Mart in effect turned the conduct of the litigation over to Selective. But the existence of this indemnity relationship was not new information. The district court was fully aware of this fact at the time it made the initial attorneys' fees determination. Moreover, the revised finding is a radical departure from the trial court's earlier conclusion that the unfortunate duration and cost of this lawsuit, and the concomitant litigation burdens imposed, were principally the result of the trial strategy of Hukafit and Selective.... To require K-Mart to pay Hukafit's legal bills under such circumstances would be manifestly unfair. (emphasis supplied). 39 Consequently, it was an abuse of discretion for the district court to change, without a reasoned explanation, its characterization of K-Mart's conduct in the litigation. Cf. Roth, 787 F.2d at 57-58 (holding that the district court abused its discretion when it employed post hoc reasoning to revise an earlier determination that plaintiff's losing claim was not baseless, frivolous, unreasonable, or brought in bad faith and to award defendant attorneys' fees). Further, because K-Mart's profits from infringement must be recalculated, an award of attorneys' fees, if any, must also be reconsidered. See N.A.S. Import, Corp. v. Chenson Enters., Inc., 968 F.2d 250, 254 (2d Cir.1992); Oboler, 714 F.2d at 213. 40 As a result, we need not reach or determine K-Mart's alternative argument that an award of attorneys' fees here is inappropriate because Hukafit hired its counsel on a 50 percent contingency fee basis. We remind the trial court on remand that it retains the authority to ensure that a contingent fee arrangement does not result in an unjustified windfall to plaintiff's counsel. Cf. Wheatley v. Ford, 679 F.2d 1037, 1041 (2d Cir.1982) (Court has power to formulate fee award designed to avoid providing a windfall to a successful attorney in a case under 42 U.S.C. Sec. 1988). The $150,000 award of attorneys' fees to Hukafit must therefore be remanded for the district court to give this issue closer scrutiny upon reconsideration. III Prejudgment Interest 41 In its March 10 damages opinion the district court declined to award Hukafit prejudgment interest. Whether an award of prejudgment interest is or is not permissible under the current Copyright Act, which neither expressly allows nor prohibits such award, remains unresolved in this Circuit. See Love, 772 F.Supp. at 1373. In a case under the 1909 Copyright Act, we affirmed--without discussion--an award of prejudgment interest. See Lottie Joplin Thomas Trust v. Crown Publishers, Inc., 592 F.2d 651, 656 (2d Cir.1978). Another circuit, upon review of the specific damage award and the statutory purpose to deter infringement, declined to award prejudgment interest to a copyright holder. See Robert R. Jones Assocs. v. Nino Homes, 858 F.2d 274, 282 (6th Cir.1988). 42 On its cross-appeal Hukafit asserts that the district court erred by not analyzing the factors set forth in Wickham Contracting Co. v. Local Union No. 3, IBEW, 955 F.2d 831, 836 (2d Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 394, 121 L.Ed.2d 302 (1992), which held that prejudgment interest could be awarded under the Labor Management Relations Act, 1947, 29 U.S.C. Sec. 187 (1988). That statute was also silent on this subject. In Wickham we said that prejudgment interest can be awarded where the court's inquiry includes analysis of the pertinent statute and its purposes; the need to fully compensate the injured party; fairness and the relative equities; and the specific circumstances of the parties and of the case. 955 F.2d at 836. Although Hukafit declares that the Wickham factors must be weighed in every case, such view misconstrues our holding. 43 Hukafit ignores Wickham 's statement that an award of prejudgment interest is equitable and discretionary. 955 F.2d at 835-36. That case guides analysis when prejudgment interest is to be awarded, but does not dictate when a particular case warrants such an award. We need not address the question of whether prejudgment interest is appropriate in copyright infringement cases generally, because here the district court did not abuse its discretion in declining to make an award. The district court's discretion is fully supported in light of Hukafit's sizable damage award and the lack of any initiative on Hukafit's part to shorten this litigation.