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MATRIX ESSENTIALS, INC. v. COSMETIC GALLERY

December 12, 1994

MATRIX ESSENTIALS, INC., Plaintiff
v.
COSMETIC GALLERY, INC., et al., Defendants



The opinion of the court was delivered by: JOSEPH E. IRENAS

 IRENAS, District Judge:

 I. PROCEDURAL HISTORY

 Matrix initiated this case in 1992, alleging claims of trademark infringement and unfair competition under the Lanham Act, 15 U.S.C. § 1051 et seq., New Jersey statutory and common law unfair competition, malicious interference with contractual relations and prospective economic advantage, the New Jersey Consumer Fraud Act, N.J.S.A. § 56:8-1 et seq., and conspiracy to commit these acts. The defendants filed an antitrust counterclaim. On February 26, 1993, the court granted defendants' motion to dismiss plaintiff's claim under the New Jersey Consumer Fraud Act, but denied that motion as to all other claims.

 On March 31, 1994, the court granted plaintiff's motion for summary judgment on defendants' counterclaim, and granted in part and denied in part defendants' motion for summary judgment. The court: (1) denied defendants' motion on plaintiff's Lanham Act and unfair competition claims to the extent that plaintiff had shown that defendants sold defaced Matrix products or permanent waves, but granted the motion to the extent that defendants had sold unaltered non-permanent wave Matrix products; and (2) granted defendants' motion for summary judgment on all other claims. On July 22, 1994, the court partially granted Matrix's motion for reconsideration, and reinstated its tortious interference with contract claim to the extent it sought injunctive, rather than monetary, relief.

 As a result of in limine motions decided October 12 and October 18, 1994, the court excluded as insufficient all plaintiff's evidence of compensatory and punitive damages. Because only injunctive relief remained, the matter was tried to the court, rather than a jury.

 At trial, plaintiff produced the testimony of Patricia Urban, Sydell Miller, Denise Melroy, Ralph DiDonato, Jr., Dennis Gullo, Robert Gullo, Mary Ann Jones, Dr. John Murphy (through a deposition taken de bene esse), Diana Lea Sandonato, portions of the deposition transcripts of Charles and Larry Eisenberg as well as many exhibits. Defendants offered the testimony Charles Eisenberg and Larry Eisenberg as well as several exhibits. Defendants' motions for judgment in its favor on all issues under Fed. R. Civ. P. 52(c), made at the close of the plaintiff's case and at the end of the trial, were denied.

 In accordance with the provisions of Fed. R. Civ. P. 52(a), the court shall "find the facts specially and state separately its conclusions of law . . . ." On December 2, 1994, the court issued its initial findings of facts and conclusions of law as well as a final judgment, and now issues its amended findings of facts and conclusions of law.

 All facts which the court finds to have been proven have been proven by a preponderance of the evidence. Where the court finds that a particular fact has not been proven, the party with the burden of proof has failed to prove that fact by a preponderance of the evidence.

 II. FINDINGS OF FACT

 1. The court deems proven each of the 16 stipulated facts set forth in Section II of the parties' Joint Final Pre-Trial Order and all other facts to which the parties stipulated during the course of the trial.

 3. Matrix was founded in August of 1980 by Arnie Miller and his wife, Sydell Miller. Mr. Miller was an experienced cosmetologist. First year sales were only $ 560,000, but by 1993 sales had soared to almost $ 200,000,000. Mr. Miller died a few years ago, and Mrs. Miller has recently sold the company for an undisclosed sum.

 4. Defendant, Cosmetic Gallery, Inc. ("Cosmetic Gallery") operated four retail beauty supply stores in Cherry Hill, Marlton, Clementon and Pleasantville, New Jersey, under the trade name Cosmetique. These stores offer for sale to retail customers a wide range of liquid products and colors and perms manufactured by a large number of different manufacturers.

 5. Defendant, C & L Beauty Supply, Inc. ("C & L") operated a wholesale beauty supply business which sold at least some of the products carried in the Cosmetique stores to other retailers on a wholesale basis. C & L's product line included liquid products and perms and colors.

 6. On November 1, 1993, while this litigation was pending, the assets of Cosmetic Gallery and C & L were sold two Florida corporations with very similar names (the "Florida corporations"). The Florida corporations were joined as defendants in this litigation shortly before the commencement of trial. On October 18, 1994, the court stayed and bifurcated the case against the Florida defendants in accordance with Fed R. Civ. P. 42(b).

 7. Prior to the sale of assets to the Florida corporations, Charles Eisenberg and Larry Eisenberg each owned 50% of Cosmetic Galleries and 25% of C & L. The sale, however, does not appear to have changed the way Cosmetique or C & L are operated. Day to day management of the stores is still in the hands of defendant Charles Eisenberg. Charles Eisenberg is the President of the Florida corporation that owns Cosmetic Gallery, and Vice President of the Florida corporation that owns C & L.

 8. Matrix markets its liquid products and its perms and colors through approximately 30 regional wholesale distributors, each with exclusive geographic territories. These distributors in turn sell the product to salons, barbershops, and beauty parlors (collectively "salons"). The exclusive Matrix distributor in the southern counties of New Jersey and Philadelphia is the DiDonato Corporation, which is located in Mercer County, New Jersey. DiDonato carries primarily Matrix and Nexxus products. Distributors agree with Matrix not to sell Matrix products to any purchaser other than a "salon," which Matrix defines as an operation that generates less than 50% of its income from the retail sale of hair care products.

 9. It is well known in the industry that Matrix does not want its liquid products sold at retail by any seller other than a salon. Many of its products carry a legend which reads to the effect: "Guaranteed only when purchased in professional salons," (Plaintiff's Ex. 14Q); or "For sale only in professional beauty salons. Our products are formulated for very specific hair and skin needs. For complete satisfaction, purchase only after consultation at an authorized salon." (Defendant's Ex. 42.) However, it was not until 1990 that Matrix began entering into written contracts with individual salons which provided that the salons would not sell other than to a retail customer for home use. This provision is contained in what have been called the Synergy Salon Success Club agreements (the "salon agreements"). (See, e.g., Plaintiff's Exs. 18 and 19.) Paragraph 7 is the restrictive paragraph of the salon agreements. It seems clear that the phrase "Matrix retail products" as used in paragraph 7 of the salon agreements refers to liquid products. The salon agreements do not actually refer to perms and colors, although it is clear that both Matrix and the salons know that Matrix does not condone the retail sale of these products. These products carry a legend which reads: "For professional use. Not for retail sale." (See, e.g., Plaintiff's Ex. 14C, a box containing Opticurl Perm). The salon agreements are three party agreements signed by Matrix, the salon and the distributor.

 10. Matrix is one of many manufacturers that desires to be known as a "salon only" seller of hair care products. Others include Nexxus, Redkin, Paul Mitchell, l'Oreal, Zotos, Goldwell, Mastey, Sebastian, Sukesha, and apparently many others. There are more than 185,000 salons in the United States, some 30% of which sell some Matrix products, and clearly salon patrons are an audience of potential buyers with a much higher propensity to purchase as compared with a typical consumer in a drug store, beauty supply store, supermarket or other kind of retail outlet that might sell hair care products. Matrix distributors generally mark up the product 40% when selling to salons. Matrix also recommends that salons mark up the product an additional 100%. Thus, if Matrix sells a bottle of shampoo to a distributor for $ 3.00, the ultimate price to the salon patron who purchases a bottle on the way out of the salon will be $ 8.40. Although there was some evidence that the markup of Matrix products by defendants was lower than that of a typical salon, there was no evidence offered by either party to show the range of markups typical of hair care products marketed through mass retail outlets.

 11. Matrix hair care products are marketed under a variety of federally registered trademarks including Matrix, Vavoom, Systeme Biolage, Opticurl, Perm Fresh, Synerfusion, and Adante. Matrix liquid products are sold at retail by salons to their customers, generally from display racks set up in the salon. Although customers may receive advice from a cosmetologist as to what product to buy, Matrix has no objection to the salon selling any liquid product selected by a patron, whether or not recommended by a salon employee. Matrix also does not object to walk-in sales, or sales to buyers who walk into a salon solely for the purpose of purchasing a product and not for any hair care service.

 12. Matrix employs some seventy-five full time educational consultants and 1000 part time consultants who visit salons and participate in various kinds of trade shows and exhibitions. These individuals give instruction in the use of various Matrix products and also serve to generate demand among salons to purchase Matrix products for resale. Although Matrix does some direct consumer advertising in magazines and on television, more money is spent on educational programs. Regardless of how a particular expense is categorized for accounting purposes, the evidence is overwhelming that educational expenditures are an integral part of the Matrix sales efforts.

 13. Because of the good reputation of many salon-only products, including Matrix products, general non-salon retailers (beauty supply stores, drug stores, and the like) try to obtain supplies of these products. The process by which retailers obtain salon-only merchandise for resale at retail is known as "diversion" and those engaged in the operation are known as diverters. Because of the profit potential to those who participate in diversion, it is a wide spread phenomenon. The attitude of manufacturers who purport to be salon-only sellers varies. Some seem to tolerate or even encourage the practice because it builds up sales, others discourage the practice but do not take strong affirmative action to stop it, while others, like Matrix, actively fight diversion.

 14. Diversion of salon-only products, like Matrix, can occur primarily in three ways. First, a wholesale distributor can sell to persons other than salons; second, salons can resell parts of their inventory to retailers; and third, persons known as "collectors" can purchase small quantities of product at numerous salons (with or without salon connivance) and resell them to retailers.

 16. Salon codes serve only to identify the salon to whom a distributor sells a Matrix product. Batch codes, on the other hand, not only identify the distributor, but also permit Matrix to locate manufacturing information relating to a product liability suit or to facilitate a product recall should one of its products prove to be hazardous or defectively manufactured. Dr. Murphy testified that at least on a few occasions the batch codes were used to facilitate recalls, although these recalls seem to have been based on the esthetic qualities of the goods rather than on a health risk associated with the recalled goods.

 17. Diverters attempt to protect themselves from detection by removing batch codes or salon codes from the product so investigators cannot determine who diverted the product. This leads to counter-measures by the manufacturers or distributors to conceal the location of the codes or to use invisible codes that can be detected only with infra-red light. For instance, when DiDonato suspected that certain salons were responsible for diversion, he would unscrew the cap of a product and place a salon code on the neck of the bottle, where it would be covered up when the cap was replaced.

 18. Diversion of salon-only products is widespread and Matrix products can be found in numerous locations around the country notwithstanding its vigorous anti-diversion program. As will be noted later in discussing diversion by the Gullo family, the lure of quick, easy profits makes wide scale diversion almost inevitable. Even today Matrix products can be found in stores located in Camden County and Philadelphia. Cherry Hill Beauty Supply, a competitor of Cosmetic Gallery, carries Matrix products and, in fact, has a store located very close to a Cosmetic Gallery store in Cherry Hill. In DiDonato's territory alone, Matrix products have turned up in over 100 retail outlets, and DiDonato's employees have purchased Matrix products at approximately fifty of those locations.

 19. Plaintiff has argued that diversion causes financial loss to the company. There is a total absence of proof to support this factual proposition. It is fairly obvious that, at least in the short run, diversions increase the manufacturer's profit by exposing the product to potential buyers other than salon customers. Plaintiff has asserted as a factual proposition that salons will stop carrying Matrix products if they are available at a nearby retail outlet. However, the only real factual support for this proposition was the testimony of one salon owner in Blackwood, New Jersey, who said she would stop selling Matrix products if they were available in nearby retail stores. There was no expert testimony offered on this issue, and there was even no testimony from Matrix's own financial personnel. Ms. Urban admitted that no salon stopped stocking Matrix products because of Cosmetic Gallery's sale of these products.

 20. Even if the court accepted as true the proposition that some salons would stop selling Matrix products if they were available in retail stores, or that such availability would reduce sales by salons that continued to stock Matrix goods, there is simply no basis for concluding that these lost sales would be greater than the increased revenue resulting from the availability of the product in ordinary retail outlets. Even less plausible is the conclusion that diversion by the defendants in this case had any adverse impact on Matrix or would have had any in the future. While the evidence does support a finding that salon-only manufacturers have widely differing attitudes towards diversion, ranging from secret encouragement to grudging acceptance to open hostility, the record is devoid of any evidence upon which one could base a finding as to which approach yields the optimal financial results. One could intuitively infer than tolerating or even secretly encouraging diversion might increase sales on a net basis, but absent competent testimony on the issue, no finding is possible either as a general matter or specifically as to Matrix.

 21. The defendants were able to obtain Matrix liquid products and perms from a variety of sources which are listed in paragraph 13 of the stipulations of fact in the Final Pretrial Order. Plaintiff does not allege that defendants sold diverted Matrix coloring products. A major source of diverted product were salons operated by the Gullo family (Dennis, Rick, Silvio ("Sal"), and Robert). From March of 1991 through April of 1992, the Gullos diverted and sold substantial quantities of salon-only products to Cosmetic Galleries. Between 15% and 25% of this diverted product was manufactured by Matrix. The Gullos purchased the Nexxus and Matrix products that they diverted from DiDonato. Dennis, Rick and Sal appear to have started diverting in March or April of 1991, while Robert did not start until July or August of 1991. It is clear that the Gullos, who worked together in the diversion efforts, were aggressive diverters who sold the defendants up to $ 10-15,000 of goods per week when diversion was at its maximum. The Gullos' markup was between 20% and 25% of their cost, resulting in a weekly profit of between $ 2,000 and $ 3,000. Since the Gullos were paid by check or cash at the time of each weekly delivery to the defendants, they made this profit with almost no capital investment and very limited expenditure of time. The large profit available to a handful of local salons demonstrates why diversion is a widespread problem throughout the country.

 22. The Gullo diversions had their genesis in early March of 1991 when Dennis Gullo made an appointment to see Charles Eisenberg concerning Gullo's desire to expand the retail sales in his recently enlarged salon. He originally considered buying a Cosmetique franchise, but this proved too expensive. Gullo viewed the diversions as a way to finance his newly expanded salon. Eisenberg promised to decode the diverted products, and generally explained to Dennis Gullo how the operation could be carried out in secrecy. To some extent Dennis Gullo distorted his testimony to lay the entire blame for the diversion on Charles Eisenberg. In fact, the evidence demonstrates convincingly that Dennis Gullo's decision to sell to Cosmetic Galleries was based on a desire to insure economic success for his new 4500 square foot salon, which included 1500 square feet devoted to retail, including two retail clerks who were not cosmetologists. It was Dennis Gullo who got other family members involved, all of whom did what they did for one simple reason--profit. Two of the Gullo diverters, Robert and Rick, had signed salon agreements which were in force during the diversion. Rick Gullo's salon agreement is dated March 8, 1991, (Plaintiff's Ex. 19) and Robert Gullo's is dated July 29, 1991, (Plaintiff's Ex. 18).

 23. In April of 1992 DiDonato ceased supplying Matrix products to the Gullos and certain related salons following Ms. Urban's purchase of Matrix products at Cosmetique stores during a visit to New Jersey. The Gullos sued Matrix in state court, and were also originally joined as defendants in this case. DiDonato resumed selling Matrix products to the Gullos as part of a settlement of both the state court case and this suit, pursuant to which the Gullos agreed to cease their diversion activities. The ...


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