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Court Scrutiny of Demand Letters: Threat or Promise?

May 1, 2020

By Andrew McIntosh and Adam Bobker

Demand letters can serve laudable purposes. They can provide notice of a legal claim and allow the recipient to assess the claim and their conduct. They can lead to resolution of a dispute without expensive and time consuming litigation. The Federal Court expressly recognized the importance of demand letters recently in Fluid Energy Group v Exaltexx Inc et al.1 But the decision also serves as a reminder of how demand letters may be tactically misused if sent without justification in order to inflict damage to a competitor’s business, without any real intention of commencing litigation. In this context, a key provision available to litigants aggrieved by an improper demand letter is section 7(a) of the Trademarks Act. Section 7(a) prohibits any person from making false or misleading statements (about intellectual property) tending to discredit the business, goods or services of a competitor. Damages and an injunction are available to an aggrieved party.

Intellectual property rights owners may be keen to send cease and desist letters to third parties in the commercial supply chain of a primary alleged infringer (such as a competing manufacturer). The purpose of such letters is typically an attempt to stop commercial dealings between the two. Where the third party complies with the demands, it may be seen as the commercial equivalent to a partial pre-trial injunction against the primary infringer. This may result in a loss of business to the manufacturer, but without the necessity of an undertaking in damages associated with an injunction. It may also provoke the third party to insist on an indemnity from the manufacturer. Hence, the Court closely scrutinizes such letters and care is needed to ensure that demand letters do not run afoul of section 7(a), as well as other actionable grounds.

Whether a demand letter is actionable can be a nuanced analysis. A few points that were discussed in the Fluid Energy Group case were:

  1. To what extent are the allegations speculative or overreaching as opposed to being factually and legally supported? A Court may find allegations that are plainly not sustainable to constitute false or misleading statements.
     
  2. The tone and form of the letter will likely inform how statements in the letter will be viewed, both with respect to whether a statement is false or misleading, and whether it discredits the business of a competitor.Informative letters, that set out a patentee’s rights and provide information that will enable the recipient to understand what may constitute infringement, will be less likely to be viewed as discrediting the business of a competitor. On the other hand, threatening letters that contain explicit or veiled threats of litigation and over reaching demands are more likely to be viewed as discrediting the business of a competitor.
     
  3. There is generally privilege attaching to statements made in litigation pleadings.But that does not mean that the statements made during litigation may be repeated outside of the litigation, or even that the claim may be sent to a third party, with impunity.While a qualified privilege may exist to fairly report on litigation, the privilege may be defeated where the statements go beyond the legitimate purposes of the occasion.Thus, to send a pleading to a third party to advise of the litigation might be privileged; but to send it in a threatening manner with the apparent intent of coercing the recipient to comply with demands may not be. The same issue may exist with characterizing allegations as statements of “belief”. In some cases they may be privileged; in other cases perhaps not.

The letters at issue in the Fluid Energy case are good examples of what may constitute a violation of section 7(a). After Fluid Energy commenced a patent infringement lawsuit against Exaltexx, it sent letters to third party suppliers who provided goods and services for Exaltexx’s “safe acid” downhole drilling fluid business at issue in the action. The letters not only alleged that Exaltexx was infringing, but also that the recipients themselves infringed (one by supplying a chemical used in the production of the fluid, and another by shipping the final product to customers). The letters stated if the recipient refused to cease the alleged infringing activities, Fluid Energy would sue, and attached the Statement of Claim from the action against Exaltexx to demonstrate the severity of the matter. They also demanded the recipient to put a litigation document hold in place. The tactic was successful with the shipping company, who felt it had no choice but to comply with the demands, and it stopped handling Exaltexx’s products.

Exxaltexx brought a motion for an interlocutory injunction to restrain Fluid Energy from sending any more letters to third parties alleging infringement, and demanding they stop dealing with Exxaltexx. The Court partly granted the relief, and enjoined Fluid Energy from communicating with any of Exaltexx’s suppliers with respect to making statements that those suppliers are infringing any of Fluid’s patents by supplying goods or services to Exaltexx, demanding that they cease from supplying goods or services to Exaltexx, or threatening to sue.

The Court found that the test for an injunction had been met – there was a serious issue to be tried that the statements made in the letters to these suppliers were false or misleading, and would discredit the business of Exaltexx, a competitor of Fluid Energy. Exaltexx established that it would suffer irreparable harm if the injunction was not granted, and the balance of convenience favoured granting the injunction.

The Court found that there was a serious issue under section 7(a) of the Trademarks Act because there was no legal basis for the allegations directly against the recipient to claim that supplying a common chemical ingredient (hydrocholoric acid), or transportation or storage of Exaltexx’s product (even if it infringed), was itself an infringement. While one part of the letter alleged that Fluid Energy “believed” that Exaltexx’s product infringed, that did not vitiate the other allegations in the letter against the recipient directly that were not couched in a such a “belief”. Exaltexx did not have first hand evidence that its product did not infringe. Therefore, it was not able to show a serious issue that it would be false and misleading for Fluid Energy to tell customers that the Exaltexx product infringes. The overall tone of the letters was very threatening, as evidenced the direct allegations of infringement, and the threat of serious legal action. This was only amplified by including the statement of claim against Exaltexx (which claimed $100M) and the demand to preserve documents.

In finding that Exaltexx would suffer irreparable harm in the absence of a pre-trial injunction, the court relied on a number of factors including that fact that it was a small business in a small market, the importance of the product in issue to its business, and the difficulty in quantifying the nature of harm that it would suffer. The Court also held that the balance of convenience favoured granting the injunction.

The case demonstrates that while demand letters may have a legitimate purpose, they must be crafted appropriately for the particular circumstance in issue, while avoiding attracting legal liability, for example under s. 7(a) of the Trademarks Act.

In addition to potential liability under s. 7(a) of the Trademarks Act, demand letters to third parties also potentially expose the sender to liability under the Competition Act, and at common law pursuant to the tort of intentional interference with economic relations. Of note, the Patent Act was recently amended to add section 76.2 which provides that demand letters must comply with prescribed requirements, and failure to comply may result in the recipient bringing an action, in which the Court may award damages and injunction. No requirements have been yet been prescribed, but when they are, patent holders must be careful to comply.


1 2020 FC 81, at para 1.

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Author(s):

Andrew McIntosh Andrew McIntosh
B.Sc. (Chem.), J.D., LL.B.
Partner
416.957.1677  email Andrew McIntosh
Adam Bobker Adam Bobker
B.Sc. (Elec. Eng.), LL.B.
Partner
416.957.1681  email Adam Bobker