The Supreme Court heard oral arguments on the issue of patent exhaustion — and that doesn’t mean people who are tired of hearing about patents.

No, the patent exhaustion doctrine, commonly referred to as the first sale doctrine, is triggered by an unconditional sale and was set way back in Mitchell v. Hawley in 1873. The doctrine holds that when a consumer purchases a patented product, that consumer owns it outright, and the patent owner may not thereafter invoke patent law to restrict its post-sale use, repair, or resale.

The courts have stated that:

[A]n unconditional sale of a patented device exhausts the patentee’s right to control the purchaser’s use of the device thereafter. The theory behind this rule is that in such a transaction, the patentee has bargained for, and received, an amount equal to the full value of the goods. This exhaustion doctrine, however, does not apply to an expressly conditional sale or license. In such a transaction, it is more reasonable to infer that the parties negotiated a price that reflects only the value of the ‘use’ rights conferred by the patentee.

However, the exhaustion doctrine changed in 1992 when the Federal Circuit declared that the doctrine was merely a unilaterally disclaimable “implied license” and that that the patent exhaustion doctrine reached only “unconditional” sales. In other words, the court held that patent owners could, through the mechanism of a “conditional sale,” impose post-sale restrictions on end-users and enforce those restrictions through suits for infringement. This ruling sent shock waves through the patent community, leading one commentator to exclaim that “a century of law under the exhaustion doctrine was abruptly swept away.”

In a suit for patent infringement, the burden of proving the establishment of an implied license falls upon the defendant. To prevail, defendants were required to establish that the products have no noninfringing uses and that the circumstances of the sale . . . ‘plainly indicate that the grant of a license should be inferred.’

The consequence is the ability of patent-holders to impose over-reaching restrictions on formerly permitted post-sale uses, repairs, modifications and resale with labels marked “single use only” or “modifications prohibited.” These notices can then be used to limit after-market competitors.

In the case between LG Electronics and Quanta Computer Inc., the U.S. Supreme Court will have a chance to decide if it wants to limit patent owners’ right to demand licensing fees after the first sale from those downstream in the manufacturing supply chain.

LG is the owner of patents relating to personal computers (e.g., systems and methods that increase the bandwidth efficiency of a computer’s system bus and a method that controls the access of a device to a bus shared by multiple devices). The patents asserted by LG do not cover the products licensed to or sold by Intel; they cover those products when combined with additional components.

LG sued Quanta for alledgedly infringing these patents when it purchased microprocessors and chipsets from Intel and installed them in computers. Intel is authorized to sell these products to them under an agreement with LG. However, pursuant to this agreement, Intel notified defendants that, although it was licensed to sell the products to them, they were not authorized under that agreement to combine the products with non-Intel products. LG brought suit against defendants, asserting that the combination of microprocessors or chipsets with other computer components infringes LG’s patents covering those combinations. LG did not assert patent rights in the microprocessors or chipsets themselves.

The trial court granted summary judgment of noninfringement of each patent. It determined that there was no implied license to any defendant, but that, with the exception of one patent, LG’s rights in any system claims were exhausted — the exhaustion doctrine did not apply to the method claims.

The trial court issued two orders on patent exhaustion. The first is unclear about which sale the court relied upon in holding LG’s system patent rights exhausted with respect to defendants, but we understand it to be LG’s license to Intel. However, the second order, which reaffirmed the first, clearly relied on Intel’s sale of its microprocessors and chipsets to defendants as the exhausting sale.

In finding the unconditional sale requirement satisfied, the trial court concluded that although “LG is entitled to impose conditions on the sale of the essential components of its patented products does not mean that it actually did so here. To the contrary, defendants’ purchase of the microprocessors and chipsets from Intel was unconditional, in that defendants’ purchase of the microprocessors and chipsets from Intel was in no way conditioned on their agreement not to combine the Intel microprocessors and chipsets with other non-Intel parts and then sell the resultant products.” The Federal Circuit didn’t agree.

At the Federal Circuit, the court held that it is “axiomatic that the patent exhaustion doctrine, commonly referred to as the first sale doctrine, is triggered by an unconditional sale.” But then it added that:

There are two sales at issue here. First, prior to this litigation, LG granted Intel a license covering its entire portfolio of patents on computer systems and components. This transaction constitutes a sale for exhaustion purposes. See United States v. Masonite Corp., 316 U.S. 265, 278 (1942). Second, with LG’s authorization, Intel sold its microprocessors and chipsets to each defendant. Notably, this sale involved a component of the asserted patented invention, not the entire patented system.

The LG-Intel license expressly disclaims granting a license allowing computer system manufacturers to combine Intel’s licensed parts with other non-Intel components. Moreover, this conditional agreement required Intel to notify its customers of the limited scope of the license, which it did. Although Intel was free to sell its microprocessors and chipsets, those sales were conditional, and Intel’s customers were expressly prohibited from infringing LG’s combination patents. Cf. N.Y. U.C.C. Law § 2-202 (allowing contracts to be supplemented by consistent additional terms unless the writing is intended to be complete and exclusive). The “exhaustion doctrine . . . does not apply to an expressly conditional sale or license,” B. Braun Med. Inc., 124 F.3d at 1426, so LG’s rights in asserting infringement of its system claims were not exhausted.

Conversely, the trial court declined to find LG’s asserted method claims exhausted. Several defendants contest this ruling on cross-appeal, and we reject their challenge. Based on the above reasoning, even if the exhaustion doctrine were applicable to method claims, it would not apply here because there was no unconditional sale. However, the sale of a device does not exhaust a patentee’s rights in its method claims. Glass Equip. Dev., Inc. v. Besten, Inc., 174 F.3d 1337, 1341 n.1 (Fed. Cir. 1999) (citing Bandag, Inc., 750 F.2d 903, 924 (Fed. Cir. 1984)). The court was correct.

In Quanta Computer v. LG Electronics, the Supreme Court is being asked whether the Federal Circuit erred by holding, in conflict with decisions of this Court and other courts of appeals, that respondent’s patent rights were not exhausted by its license agreement with Intel Corporation, and Intel’s subsequent sale of product under the license to petitioners.

On January 16, 2008, the Supreme Court heard oral argument on applying the patent exhaustion doctrine and on the limits of a patentee’s downstream control over sold products containing a claimed invention.

Maureen Mahoney, for Quanta, argued that patent exhaustion has always been triggered when two criteria have been satisfied and the district court properly dismissed these claims because it found that they were satisfied here on the undisputed facts. The first is that there must be an authorized sale under the patent that was allegedly infringed. That’s never been in dispute in this case. The Federal Circuit recognized that Intel was authorized to sell these components under the system and method patents at issue in the case that have been allegedly infringed. And the second criteria is that the article sold must be one that falls within the protection of the patent that was allegedly infringed, here the system and method patents.

JUSTICE GINSBURG: Could the patentee say to the licensee, to the Intel, that, I license you to sell only to buyers who have a license from the patentee? Could — could the licensee be limited in that way?

MS. MAHONEY: They could do that, and let me explain the consequences of doing that. If Intel then under those circumstances sold to a buyer who did not have a license, Intel would be liable for contributory infringement because it wouldn’t be an authorized sale, and the buyer would be liable for infringement because it didn’t acquire the goods through an authorized sale. If the buyer instead has the license, has obtained the license from the patent owner, then there has been an authorized sale and any remedies that the owner of the patent would have against the buyer would be those found in contract, because the triggering line under this Court’s cases is has there been an authorized sale.

CHIEF JUSTICE ROBERTS: So the parties are unwilling to spell out exactly how this is going to work out in their contract, and each side, it prefers to take their chances on how the Federal Circuit’s going to rule. It’s easier to sell these things if they’re not encumbered by these additional license requirements and the manufacturer presumably gets a lot more, but there’s a lot of uncertainty, uncertainty that could have been cured by how the contract was drafted, and people prefer to live with that uncertainty and litigate rather than clear it up in the contract.

Deputy Solicitor General Thomas Hungar testified on behalf of the U.S. Government. Hunger argued that an authorized sale removes the particular item sold from the protection of the patent laws and that the trial court erroneously transformed that patent-exhaustion doctrine from a definitional principle that delimits the scope of the patent grant into an optional default assumption

JUSTICE SOUTER: So there could be a restriction in the license which is not a restriction on sale and that could be violated. And the exhaustion doctrine would still apply, and you might have remedies in some another theory, i.e., contract.

MR. HUNGAR: That’s correct. That’s correct. Likewise, what happens in the real world is the patentee, if the patentee wants to restrict what people can do downstream, they say to the licensee, you can only sell if you obtain a contractual promise from the purchaser.

JUSTICE STEVENS: Are you saying that this case would come out differently if instead of just requiring a notice that the — the item should only be used on Intel products, that had been a condition of the license. If the license itself said you may manufacture and sell to only people who agree to use the product exclusively with Intel products?

MR. HUNGAR: Yes. In if those circumstances, if Quanta had — if that — if that license condition –

JUSTICE STEVENS: So the key fact in this case is it was just a requirement of giving notice rather than a condition in the license?

MR. HUNGAR: But let me be clear. The key distinction is between an authorized sale and an unauthorized sale. So if there is an authorized sale, that is, Intel.

Carter Phillips, for LG, tried to shift the focus to what is the “it” that we are talking about?

CHIEF JUSTICE ROBERTS: Well, but there’s nothing to do with these chipsets other than use them in the computers. I mean, you don’t put them on your shelf. They’re not good for anything other than using in the computer. So saying there’s a separate patent for how you use them with the other systems doesn’t seem to be very significant.

MR. PHILLIPS: It would be — and that’s why you would ordinarily — you don’t deal with this as an exhaustion issue. That’s why you would deal with this as an implied licensing issue. The assumption would be, in the absence of clear evidence to the contrary, that if I’m selling you something that only has a single use and that’s in a separate patent, that you in fact are being licensed to go and use it that way. But what’s absolutely critical in this case is that both the district court and the court of appeals specifically rejected the notion that there was any implied license. And it’s important to realize this.-

JUSTICE BREYER: Imagine that I want to buy some bicycle pedals, so I go to the bicycle shop. These are fabulous pedals. The inventor has licensed somebody to make them, and he sold them to the shop, make and sell them. He sold them to the shop. I go buy the pedals. I put it in my bicycle. I start pedaling down the road. Now, we don’t want 19 patent inspectors chasing me or all of the other companies and there are many doctrines in the law designed to stop that. One is the equitable servitudes on chattel. Another is the exhaustion of a patent. And now you talk about implied license. I would say, why does it make that much difference? What we’re talking about here is whether after those pedals are sold to me under an agreement that the patent — you know, you have a right to sell them to me — why can’t I look at this as saying that patent is exhausted, the patent on the pedals and the patent for those bicycles insofar as that patent for the bicycles says I have a patent on inserting the pedal into a bicycle. Call it exhaustion, call it implied license. Who cares?

MR. PHILLIPS: I don’t have any problem with your hypothetical because it’s not this case. Your hypothetical deals with the situation of what would have happened if you had bought the chip. Would we be in a position to say, even though you bought the chip, we nevertheless want to retain some right to come out — to come after you claiming we still have a patent in that chip? And the answer is no. We exhausted — that was exhausted by the sale of the chip. The question is if you buy a pedal, can you then take that pedal that was designed for a bicycle, put it into a Stair Master –

JUSTICE BREYER: Yes. Of course, I think the answer to that is no, probably no, but, but, but, but. Now you can clarify this because I may be off on a wrong track. I thought we’re talking about using the sold item in those mechanisms which account for virtually almost the only logical use of the sold item. Thus, if you took the bicycle blanks — not the bicycle blanks; they are eyeglass blanks. I’m mixed up between bicycles and eyeglasses, there we are. But if you took the eyeglass blanks and you use them for the purpose of growing plants instead of inserting them into eyeglasses, I guess we’d have had a different case.

And I take it here they are using those chips in those mechanisms that the chips are almost exclusively designed for and there isn’t much else to use them for. Am I right or wrong?

MR. PHILLIPS: That is true. But the — but the point here is that that’s not the relevant distinction. It’s not whether or not this is in some sense an essential use. What this Court said in Univis is that this would be a very — that would have been a very different case if there had been a separate patent on the grinding and finishing of those lenses. And that is precisely our case. There is a separate patent when you take those components and you then put them into our separate system.

And from my perspective, Your Honor, the better way to analyze this is not as a question of exhaustion. Let’s keep the exhaustion doctrine where it fits. It’s a first sale component. You buy it, you exhaust. Let’s use the implied licensing as the mechanism for dealing with related patents. But the beauty of that in this case, obviously, is that — is that the implied license in this case the courts below have flatly said doesn’t exist. And it goes to the point that you made, Justice Breyer, as well when you said, you know, I buy this and I sort of assume that I’m going to be able to use it in a particular way. These — this is a $10 billion company that at the time they bought these components, these chips, received explicit and specific notice that the one thing they could not do was use these chips to build new systems and then sell those systems, obviously, beyond — you know, under a completely separate patent.

A ruling in the LG-Quanta suit is expected by July.

Read the whole transcript here.

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    As the Respondent (LQ Electronics) and most of the Amici supporting the Respondent have noted (some more strongly than others such as AIPLA), the impact of 35 USC 271(d) was not part of this oral argument. 35 USC 271(d) may have overturned the patent exhaustion doctrine, either explicitly or implicitly (by its language). I’m not optimistic that SCOTUS will deal with the impact of 35 USC 271(d) on patent exhaustion, even though it should as this section was enacted to curb a whole line of SCOTUS doctrine (including misuse) that curtailed the patentee’s ability to enforce its rights.

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