Advisories June 2, 2017

Intellectual Property Advisory: U.S. Supreme Court Sets the Tone for Patent Exhaustion

Executive Summary
Minute Read

Patent holders are going to have get creative (again) when managing their portfolios thanks to the Supreme Court’s decision reversing years of precedent (again). Our Intellectual Property Group examines the decision and explores the future of patent licensing.

  • The doctrine of patent exhaustion
  • The Court’s reversal
  • Implications for patent owners
Earlier this week, the Supreme Court altered the landscape of patent exhaustion in Impression Products Inc. v. Lexmark International Inc. The Court, in reversing the Federal Circuit, held that a patentee’s decision to sell a product exhausts all patent rights in that item, regardless of any restrictions the patentee purports to impose or the location of sale.

As a result, a patentee who sells a product, whether domestically or internationally, cannot later sue for patent infringement relating to use or resale of that item. Rather, patentees who sell products under their U.S. patents, but who want to restrict downstream use or resale of those products, will have to rely on, and enforce, contract rights against their customers. Similarly, patentees who license their U.S. patent rights will need to craft their licenses very carefully to delineate what is licensed and what is not and to consider enforcement mechanisms and strategies that will enable them to achieve their licensing goals.

The Doctrine of Patent Exhaustion

The Patent Act, 35 U.S.C. § 154(a), grants patentees the “right to exclude others from making, using, offering for sale, or selling [their] invention[s].” But this right to exclude is limited by the doctrine of exhaustion. At its core, patent exhaustion concerns the level of control a patentee has over its products after they are sold. Under the doctrine, once a patent owner sells a patented product, it cannot later claim that the use or resale of that product infringes the patent.

The dispute between Impression Products and Lexmark centered on Impression Products’ attempts to circumvent restrictions on the refilling and resale of Lexmark’s printer toner cartridges. When Lexmark sells its cartridges, it provides consumers with two options: to buy a cartridge at full price with no restrictions or to participate in the Return Program, meaning to buy a cartridge at a discount and agree to use the cartridge only once and refrain from transferring that cartridge to any party other than Lexmark. But remanufacturers, including Impression Products, acquire empty cartridges from purchasers in the U.S., refill them with toner, and then resell. Such companies also acquire cartridges from purchasers overseas and import them into the U.S.

Impression Products argued that Lexmark’s sales in the U.S. and abroad exhausted its patent rights in the cartridges, so Impression Products was free to resell and import the used products. The Federal Circuit disagreed, finding instead that patent owners may sell a product domestically and retain the right to enforce—through patent infringement actions, for example—clearly communicated, lawful restrictions on post-sale use or resale of the patented products. Further, the Federal Circuit held that when a patentee sells a product overseas, it does not exhaust its U.S. patent rights in that item.

Supreme Court Opinion

The Supreme Court revisited domestic and international patent exhaustion earlier this week and reversed the Federal Circuit’s decision.

Addressing the domestic patent exhaustion issue, as exemplified by the Return Program, the Court held that Lexmark exhausted its patent rights in the cartridges the moment it sold them. While the single-use and no-resale restrictions may create enforceable contract rights, they did not entitle Lexmark to retain any patent rights. The Court first explained that the exhaustion rule marks the point where patent rights yield to the common law principle against restraints on alienation. In doing so, the Court emphasized the historical role of this principle in the copyright context and Congress’s repeated revisions of the Patent Act against the backdrop of hostility toward restraints on alienation. As an illustration, the Court compared patent rights to an auto shop that restores and resells used cars, noting that the business works because the shop can rest assured that it is free to repair and resell those vehicles.

The Court then considered its prior holdings that, even when a patentee sells an item under an express restriction, the patentee does not retain patent rights in that product. The Court further relied on its 2008 decision in Quanta Computer v. LG Electronics, which held that the “authorized sale … took its products outside the scope of the patent monopoly,” to conclude that once sold, the Return Program cartridges passed outside of the patent monopoly, and whatever rights Lexmark retained are a matter of contracts with its purchasers rather than patent law.

Addressing the international patent exhaustion issue, involving Impression Products’ practice of purchasing used cartridges abroad and importing them into the U.S., the Court held that an authorized sale outside the U.S. also exhausts all rights under the Patent Act. The Court looked to the application of the analogous “first sale doctrine” in copyright law, which applies to copies of a copyrighted work lawfully made and sold abroad. “Applying patent exhaustion to foreign sales,” the Court noted, “is just as straightforward.”

The Court also rejected Lexmark’s argument that the territorial limit on patent rights serves as a basis for treating international exhaustion differently, instead observing that a “purchaser buys an item, not patent rights.” The Court here distinguished Boesch v. Graff, an 1890 decision holding that a sale abroad did not exhaust a patentee’s rights when the patentee had nothing to do with the transaction. There, a foreign manufacturer was authorized under German law to make the patented product, but the German manufacturer had no ties to the U.S. patentees. The U.S. patentees sued a retailer for infringement when the retailer imported that product from Germany into the U.S. The Court rejected the argument that the German manufacturer’s sale exhausted the American patentees’ rights because the U.S. patentees were not involved in the sale.

The United States, as a third-party amicus, advocated a middle-ground position that “a foreign sale authorized by the U.S. patentee exhausts U.S. patent rights unless those rights are expressly reserved.” The Court also rejected this argument because “sparse and inconsistent decisions” provided no basis for an expectation that patentees may reserve patent rights when they sell abroad. The Court further noted that it is not the parties’ expectations (which can be addressed through contract law) that give rise to exhaustion. Rather, what matters is the patentee’s decision to make the sale—a decision premised on the long-standing principle against restraints on alienation.

Justice Ruth Bader Ginsburg, who dissented in part, argued that a foreign sale does not exhaust an inventor’s domestic patent rights because patent law is territorial.

Implications for Patent Owners

The Supreme Court’s holding is relatively straightforward for patentees who make and sell products under their own patents. Going forward, those patentees will know that they cannot prevent exhaustion by placing restrictions on such sales or by selling abroad. In order to limit or prevent certain downstream uses of the products, patentees will need to rely on, and enforce, contracts with their purchasers.

Perhaps most noteworthy is the effect this decision will have on patentees who license their patent rights to others. For instance, if a U.S. patentee also has patent rights abroad and no facilities to manufacture abroad, but nonetheless wants to monetize its patent rights abroad by licensing, the patentee is now at risk that the licensed products made abroad could later flood the U.S. market and impact that patentee’s U.S. business. The Supreme Court explained that the patentee can require the licensee to impose restrictions in its purchasers (such as, for example, refraining from importing to the U.S. or refraining from using the patented product in certain applications), but in such instances, the patentee may nonetheless be left with only a breach of contract claim against the licensee if it fails to do so. Moreover, if the licensee complies and imposes such a restriction on its customer, but the licensee’s customer violates that restriction and imports to the U.S. or uses in a restricted application, then the U.S. patentee may be left with no recourse.

Going forward, licensors of U.S. patents will need to be creative and thorough in drafting their licenses and managing their patent portfolios in order to ensure that their licenses do not convey more rights than intended and to ensure that proper enforcement mechanisms are put in place. Additionally, because the Supreme Court’s ruling likely applies retroactively (as most judicial decisions do), patentees will need to examine their existing licenses to determine the potential impact the decision may have on those licenses and, if possible, may need to renegotiate with licensees.
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