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EasyTone Case Raises Some Hard E&O Issues
October 7, 2011 – On September 28, the Federal Trade Commission
announced that shoe and apparel company Reebok agreed to pay $25
million to settle a lawsuit alleging that Reebok's "EasyTone" shoes
were advertised in a deceptive manner. The FTC's press release can be
found here: http://www.ftc.gov/opa/2011/09/reebok.shtm
The FTC's lawsuit alleged that Reebok's ads deceptively represented
that "tests show that when compared to walking in a typical walking
shoe, walking in EasyTone footwear will improve muscle tone and
strength by 28% in the gluteus maximus, 11% in the hamstrings, and
11% in the calves." In a statement, Reebok said that it stands behind
its EasyTone technology, that it chose to settle the case "to avoid a
protracted legal battle," and that the settlement "does not mean we
agreed with the FTC's allegations; we do not." Under the settlement,
the $25 million judgment will be paid into an escrow account and
made available for refunds to consumers who bought certain Reebok
products.
While many details were not made public, $25 million seems like an
awful a lot of money to settle a case just to "avoid a protracted legal
battle" – yes, defense costs are expensive, but $25 million will pay for
a whole lot of lawyering. To us, this high-profile settlement serves as a
wake-up call about the risks arising out of consumer advertising. As
noted in a recent Trademark and Copyright Law blog, the FTC takes
the position that all claims, express and implied, must be
substantiated at the time the claims are made, and an advertisement
can even be deceptive by omission. Advertisers should be particularly
careful with respect to claims asserting that tests or studies prove a
certain fact. Such claims can give rise to liability if the tests were not
sufficiently reliable or if they did not fully support the proposition
claimed. False advertising can lead to lawsuits not only by the FTC, but
also by competitors under the Lanham Act (15 U.S.C. §
1125(a)(1)(B)), and class actions by consumers. See
http://www.trademarkandcopyrightlawblog.com/2011/09/articles/false
-advertising-1/reebok-settles-false-advertising-case-with-ftc-returns25-million-to-purchasers-of-easytone-shoes/
The Reebok case also raises a number of challenging E&O insurance
issues. As we have noted previously in ThinkFriday, see
http://www.thinkrisk.com/thinkfriday/2011_03_04.php?site=USA,
false advertising is an often misunderstood topic within the insurance
industry. Most E&O policies, even policies that are designed specifically
to provide media and advertising coverage, contain some form of false
advertising exclusion. This is understandable – false advertising cases
are notoriously expensive to defend, and some underwriters may feel
that there is an element of moral hazard in providing false advertising
coverage. Nevertheless, as professional liability underwriters we
provide coverage for many other types of claims that are costly to
litigate, and we even provide coverage for claims that involve an
element of falsity – libel claims, for example, which are a mainstay of
media liability coverage, by definition require an allegation that an
insured made a false statement; indeed, if the plaintiff is a public
official or public figure, the false statement must have been made
knowingly or at least recklessly. Yet we have insured companies
against libel claims for decades.
Other important insurance issued are raised by the Reebok settlement
as well. First, as noted above, the settlement consisted of a large pool
of money set aside to make refunds to customers who purchased
certain products. Whether these types of "consumer restitution funds"
– which are quite common in the resolution of consumer-related
litigation – constitute "loss" under an E&O policy is a frequently
disputed issue in the adjustment of E&O claims. Claims adjusters often
take the position that consumer restitution is a cost of doing business,
rather than legal damages, and therefore not covered. Insureds, on
the other hand, argue that this puts form over substance, since if they
refuse to settle the claim by making restitution, the likely costs to the
insured in ongoing defense expenses and potential damages could be
even greater. Second, note that the Reebok action was brought by the
FTC, not by a private plaintiff (although it appears that the settlement
might be enforced through a class action lawsuit). Many E&O policies
(including ours), however, have regulatory exclusions that limit their
usefulness in connection with claims brought by government
agencies.
Given these uncertainties, we believe that a clearer and more robust
insurance solution to false advertising exposure is needed. To be sure,
this coverage needs to be underwritten carefully. Underwriters need to
evaluate the insured's legal and risk management practices to make
sure the insured is taking all appropriate steps to validate claims made
in advertising, and to otherwise comply with advertising law. Sublimits
and separate retentions are very useful tools in this area, both to
manage the potential severity of these claims and to address the
potential moral hazard by making sure the insured has something at
stake as well. And the solution should contemplate that consumer
restitution is likely to be an element of settlements in this arena, and
clarify the extent to which such settlements will be included in
coverage.