United States v. Zen Magnets, LLC

Citations: 170 F. Supp. 3d 1365; 2016 U.S. Dist. LEXIS 36888; 2016 WL 1114560Docket: Civil Action No. 15-cv-00955

Court: District Court, D. Colorado; March 22, 2016; Federal District Court

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The court has granted the Consumer Product Safety Commission's (CPSC) motion for summary judgment against Defendants, who are selling small, powerful magnets despite prior warnings from the CPSC. The CPSC alleges that these sales violate the Consumer Product Safety Act (CPSA) due to a recall of the magnets, which Defendants purchased from Star Networks, USA LLC. The court previously issued a preliminary injunction on May 14, 2015, prohibiting the Defendants from selling these magnets.

The case originated in March 2015 when the CPSC discovered that Defendants, led by Shihan Qu of Zen Magnets, LLC, were marketing magnets known for causing severe injuries, particularly in children. Reports indicated that ingestion of multiple magnets could lead to serious gastrointestinal injuries, potentially fatal if untreated.

The CPSC and Zen had previously engaged in settlement discussions after the agency filed administrative complaints against both Zen and Star for failing to cease sales and recall the magnets. On July 10, 2014, Zen purchased 917,000 magnets from Star at a significant discount, shortly before Star entered into a Consent Agreement with the CPSC to stop sales of these magnets and conduct a recall. The Consent Agreement defined the magnets as "Subject Products" under the CPSA, confirming their classification as hazardous consumer items.

The court concluded that there are no genuine issues of material fact regarding the Defendants' violations of the CPSA, leading to the granting of summary judgment and the request for a permanent injunction against the Defendants' sales activities related to these magnets.

Defendants mixed sphere-shaped Star Magnets with indistinguishable sphere-shaped magnets from Zen's inventory, selling the combination as "Neoballs," while repackaging cube-shaped Star Magnets as "NewbCubes" without mixing them. No physical alterations were made to the Star Magnets before repackaging. Following a CPSC settlement announcement with Star on August 4, 2014, Zen's representative Qu claimed Zen was the last sphere magnet company in the U.S. and vowed to resist CPSC's prohibition until failure or insolvency. Zen also linked to the CPSC's settlement on its website. 

On March 4, 2015, the CPSC issued a notice of noncompliance to Qu, demanding an immediate halt to sales of the Star Magnets, citing violations of 15 U.S.C. 2068(a)(2)(B) and (C). Qu replied on March 6, stating Zen could not confirm cessation of sales as the magnets were "destroyed, unbranded, and converted to the raw magnets," which he argued were not prohibited. In a follow-up on March 20, Qu acknowledged that Zen had sold all cube-shaped Star Magnets but continued selling the Neoballs. 

The CPSC reiterated its stance on April 3, warning Zen of potential legal action, including injunctive relief and civil or criminal penalties. Qu’s attorney responded on April 7, maintaining that Zen was not violating the CPSA due to the repackaging of the magnets.

On May 5, 2015, the CPSC filed a Complaint against Defendants for violations of the CPSA, along with a Motion for Preliminary Injunction to prevent the sale of Star Magnets and demand destruction of those in Defendants' possession, as well as a recall of already sold products. A half-day evidentiary hearing took place on May 11, 2015, where Defendant Qu acknowledged awareness of ongoing settlement negotiations between Star and the CPSC when he purchased the magnets and admitted knowledge of an impending Consent Agreement likely making the sale of Magnicube products illegal. The Court partially granted the Motion for Preliminary Injunction on May 14, 2015, requiring Defendants to quarantine all Star Magnets and prohibiting further sales of small magnets with a flux index greater than 50 purchased from Star Networks, USA LLC. An Order was entered on June 12, 2015, extending the preliminary injunction until the case's resolution. The CPSC's current Motion seeks permanent injunctive relief against the sale and distribution of "Repackaged Star Magnets," requests a recall of those sold before May 14, 2015, mandates full refunds for returns, and calls for the destruction of remaining inventory. Additionally, the Motion seeks summary judgment on the claim that Defendants knowingly violated the CPSA, allowing for potential civil penalties under 15 U.S.C. 2069(a)(1)(b).

Summary judgment is appropriate when the moving party demonstrates no genuine dispute exists regarding any material fact and is entitled to judgment as a matter of law. A fact is considered "material" if it is crucial for resolving the claim under applicable law, while a "genuine" dispute arises when evidence could reasonably lead a jury to favor the non-moving party. Courts must evaluate evidence in the light most favorable to the non-moving party, though mere conjecture or subjective beliefs are insufficient as competent evidence. In this case, the Consumer Product Safety Commission (CPSC) carries the initial burden of proving the absence of a genuine dispute and entitlement to judgment. The CPSC does not have to disprove the opposing party's claims but must indicate a lack of evidence on an essential claim element. Once this initial burden is met, the non-moving party must present specific, admissible facts to demonstrate a genuine trial issue, relying on affidavits, depositions, or specific exhibits.

The CPSC is empowered by the Consumer Product Safety Act (CPSA) to safeguard the public from unsafe consumer products, including bringing administrative actions against manufacturers. Under 15 U.S.C. 2068, the CPSC can prevent the resale of products subject to voluntary corrective actions after a settlement. This section prohibits the sale or distribution of any consumer product that has undergone such corrective actions, if the seller is aware or should be aware of them. For the CPSC to secure permanent injunctive relief under 15 U.S.C. 2071(a)(1), it must show no genuine issues exist regarding the defendants' violations of Section 2068. The defendants have admitted to all material facts indicating their violations, specifically acknowledging that they sold consumer products (Repackaged Star Magnets) subject to voluntary corrective actions that were publicly notified by the CPSC. Zen confirmed the sale of these products from December 2014 to May 2015 and admitted to selling 114,000 magnetic cubes and having approximately 500,000 remaining units in inventory as of May 11, 2015, establishing that the Repackaged Star Magnets were indeed consumer products sold by the defendants.

Zen sold consumer products defined as "Subject Products" under a Consent Agreement between Star and the CPSC, which mandated Star to stop selling, recall, and destroy these products. Zen acknowledges that it sold Repackaged Star Magnets branded as "Neoballs" and "NewbCubes," purchased from Star just before the Consent Agreement was signed on July 17, 2014. Zen's admissions confirm a violation of section 2068, specifically regarding the sale of these Subject Products. Although Zen contends that a factual dispute exists regarding whether the Repackaged Star Magnets fall under the definition of "Subject Products," the Court finds no genuine disputes. Zen's argument that the Consent Agreement confines the definition of "Subject Products" to those marketed as Magnicube is rejected, as the Agreement's definition encompasses a broader range of products, not limited by branding or packaging. The Consent Agreement explicitly identifies the Subject Products based on their specifications rather than their marketing identity, thus reaffirming Zen's liability.

The definition identifies "small, individual magnets with a flux index greater than 50" as those sold under the brand names Magnicube Magnet Balls and Magnicube Magnet Cubes. This identification is crucial for retailers, like Zen, to ascertain which products fall under a Consent Agreement. The Consent Agreement specifies that its provisions are to be interpreted reasonably to address the hazards alleged in the Complaint, which encompass not only inadequate warning labels but also inherent design defects in the magnets themselves that pose a substantial risk of injury. The administrative Complaint against Star asserted these defects, demonstrating that the raw Star Magnets are included as "Subject Products" governed by the Consent Agreement.

Defendants argue that without the original packaging and warning labels, the raw Star Magnets were identical to magnets they were allowed to sell, suggesting their remarketing and repackaging rendered them fundamentally different products. However, this argument is dismissed as irrelevant; the Consent Agreement specifically governs the 917,000 small magnets introduced into commerce by Star after August 2010. Zen's ability to sell other magnets does not impact whether it sold magnets included in the Consent Agreement. Furthermore, it is admitted that Defendants did not alter the Star Magnets physically. The assertion that new packaging and warnings made the raw Star Magnets fundamentally different is considered a distraction. The Consumer Product Safety Act (CPSA) prohibits the sale of any consumer product subject to voluntary corrective action, regardless of any modifications made by the seller. Thus, as of July 17, 2014, the date the Consent Agreement was signed, the Star Magnets remained "Subject Products," and Defendants' repackaging does not alter their violation of Section 2068.

Zen contends that Star Magnets should not be classified as “Subject Products” because Star did not explicitly acknowledge their hazard or defect in the Consent Agreement. However, this argument is irrelevant; Section 2068 does not mandate such admissions from manufacturers. The primary issue in this litigation is whether Defendants sold products covered by the Consent Agreement, rather than whether those products posed a substantial hazard. The CPSC has publicly notified about the voluntary corrective action involving Star, and Defendants are aware of this notification, as they do not dispute that the CPSC effectively communicated the Consent Agreement via its website. Zen also acknowledged the Agreement by linking to it on its website. Consequently, there are no material facts in dispute regarding the third element of Section 2068. 

Defendants are found to have violated Section 2068, as they sold products that fell under the Consent Agreement, which the CPSC had made public and which Defendants knew about. As a result, the CPSC is entitled to summary judgment on its claim and seeks a permanent injunction preventing Defendants from selling or distributing the Repackaged Star Magnets. Additionally, the CPSC requests a court order for Defendants to recall the Repackaged Star Magnets already sold and provide full refunds to consumers. The CPSC argues that Section 2071 grants the court jurisdiction to restrain violations of Section 2068 and that courts have historically upheld the authority to issue backward-looking remedies, as seen in relevant case law. This position is supported by the Tenth Circuit's ruling in United States v. Rx Depot, Inc., which confirmed the court's equitable powers to impose such remedies when authorized by statute.

The Court analyzed the Consumer Product Safety Act (CPSA) and concluded that it does not limit the forms of equitable relief available. Although Section 2071 mentions “restrain,” which may suggest remedies are restricted to future violations, the Tenth Circuit in Rx Depot clarified that this term does not definitively indicate Congressional intent to limit remedies. The CPSA includes provisions, such as 15 U.S.C. 2072, allowing individuals harmed by violations to sue for damages, but the existence of these provisions does not imply an exclusion of other remedies or a limitation on the Court's equitable jurisdiction. The case, initiated by the Government, aims to protect public health and safety from risks associated with consumer products, thereby expanding equitable jurisdiction under the CPSA. The Court found that ordering a recall aligns with CPSA’s goals, as it mitigates consumer risk and deters future violations by forcing defendants to issue refunds and return profits from illegal sales. Disgorgement serves to deter unlawful conduct by making it financially disadvantageous. The CPSA grants the Court equitable jurisdiction to address violations of Section 2068, which includes the authority to order a recall, deemed appropriate in this instance. Consequently, the Court will mandate the Defendants to recall the Repackaged Star Magnets as outlined in the concluding part of the Order.

Civil penalties may be assessed against Defendants under 15 U.S.C. 2069(a) for each "knowingly" committed violation of section 2068. The current motion seeks a determination of whether Defendants acted with knowledge of their violations, rather than the number or amount of penalties. The Consumer Product Safety Commission (CPSC) will submit further briefing if the Court finds knowledge. Defendants did not adequately respond to the CPSC's claims regarding civil penalties and contend they believed in good faith that they were complying with the Consumer Product Safety Act when repackaging and selling Star Magnets. 

"Knowingly" is defined as either actual knowledge or presumed knowledge that a reasonable person would possess under the circumstances. Defendants' admissions indicate sufficient knowledge, particularly regarding Section 2069(d)(2). During a preliminary injunction hearing, Qu acknowledged awareness of an impending Consent Agreement with the CPSC and the reasons for the significant discount on Star Magnets. He also admitted responsibility for Zen's website postings, which referenced the Consent Agreement and linked to it. Despite knowing about the Consent Agreement, Defendants did not separate the Star Magnets from other magnets and continued selling them after receiving warnings from the CPSC and even after the CPSC's Complaint, until an injunction was issued on May 11, 2015. These actions demonstrate that Qu, while possibly lacking actual knowledge of the Consent Agreement's applicability, had sufficient notice to fulfill the duty of a reasonable person to ascertain the truth regarding the Star Magnets' status as "Subject Products."

Defendants failed to confirm their belief that removing Star Magnets from original packaging exempted them from a Consent Agreement, neglecting to exercise due care and ignoring repeated warnings from the CPSC. Despite the CPSC's explicit warnings regarding their "un-branding" and "repackaging" strategy, Defendants continued selling the magnets, leading the CPSC to establish that their violations of Section 2068 were "knowing." The court granted the CPSC's motion for summary judgment, resulting in a permanent injunction against Defendants from selling or distributing small magnets with a flux index greater than 50 that were purchased from Star Networks, USA LLC. All indistinguishable magnets combined with the Star Magnets are included as "Star Magnets" for compliance purposes. Defendants must post a notice of this order on their website for two years, offering full refunds for returned Star Magnets and prorated refunds for partial returns. They are also required to announce this order on social media, email notice to purchasers, and provide a copy of the order to all associated parties within specified timeframes.

Defendants are required to provide a copy of the court order to any new Associated Persons involved in the sale or distribution of Star Magnets within ten business days of such association. They must also submit an affidavit detailing compliance with this requirement, including the names and addresses of those who received the order and attach mail return receipts. Defendants are ordered to timely destroy or dispose of all Star Magnets in their inventory and distribution chain, notifying CPSC staff beforehand to allow them to witness the process. Additionally, Defendants must quarantine the Star Magnets to prevent their reentry into commerce. The CPSC staff is granted the authority to conduct unannounced visits for compliance verification.

Defendants are restrained from actions that violate 15 U.S.C. 2068(a)(2)(C), and the court retains jurisdiction for enforcement or modification of the order. The CPSC is instructed to provide recommendations for civil penalties to the court by April 6, 2016, with Defendants required to respond within two weeks. The parties are to coordinate a hearing date regarding civil penalties.

An administrative complaint against Zen is pending before an Administrative Law Judge and does not pertain to Star Magnets, only to those in Zen's inventory before a transaction with Star. The CPSC's Final Rule for Magnet Sets, effective for magnets manufactured or imported after April 1, 2015, also does not apply to Star Magnets; Zen is appealing this rule in the Tenth Circuit. The CPSC has not defined "magnetic flux," which is considered synonymous with magnetic strength.

The Court refrained from ordering a recall due to uncertainties regarding its authority under the CPSA and the nature of preliminary injunctions, which aim to maintain the status quo until a trial occurs. However, it later determined it possessed the authority to mandate a recall under 15 U.S.C. § 2071(a)(1), which allows federal courts to restrain violations of 15 U.S.C. § 2068. The CPSC's Complaint alleged violations of both 2068(a)(2)(B) and 2068(a)(2)(C), with the latter concerning the prohibition against selling products subject to an order under sections 12 or 15 of the CPSA. The CPSC indicated it would not pursue the 2068(a)(2)(C) claim if the motion was granted on the other claim.

The CPSA defines "manufacturer" broadly, covering anyone involved in the manufacture or import of consumer products. Following a regulation effective April 1, 2015, the sale of small magnets with a flux index greater than 50 became illegal, a standard currently under challenge by Defendants in the Tenth Circuit. Defendants’ actions in mixing the Star Magnets, which were subject to a recall, with their own indistinguishable magnets complicate the injunction process. Despite asserting that the "Subject Products" of a Consent Agreement differ from the Star Magnets, Zen failed to substantiate this claim with relevant language from the CPSC’s Complaints. The Court found that Defendants’ voluntary intermixing of the magnets necessitated including all indistinguishable magnets in the injunction to effectively prevent sales of the recalled products.

The Court highlighted the principle that those who approach prohibited conduct do so at their own risk, emphasizing that equitable remedies can be broad and flexible. During the preliminary injunction hearing, a witness acknowledged the intermixing of magnets despite ongoing litigation, failing to recognize the associated risks.