CASRIP Newsletter - Summer 2008, Volume 15, Issue 2
Quanta Computer v. LG Electronics: The Supreme Court Applies Its Patent Exhaustion Precedent and Rejects Recent Federal Circuit Modifications of the Doctrine
by Greg A. McAllister
The Supreme Court recently issued a unanimous opinion on the scope of the patent exhaustion doctrine in Quanta Computer, Inc. v. LG Electronics, Inc. The case overturns the Federal Circuit’s patent exhaustion jurisprudence, under which patent rights were exhausted only by unconditional sales, which could be unilaterally imposed and enforced under the patent laws. Quanta replaces the Federal Circuit’s “unconditional sale” rule with one that determines exhaustion based on any “authorized sale.” Quanta has broad implications on licenses in a number of different fields. Since the focus is now on authorization to sell, rather than conditions accompanying the sale, a patentee cannot impose restraints on a downstream purchaser that it does not also impose on the licensee who sold to that downstream purchaser.
Quanta holds that “[t]he authorized sale of an article that substantially embodies a patent exhausts the patent holder’s rights and prevents the patent holder from invoking patent law to control postsale use of the article.” In a further repudiation of the Federal Circuit, the Court held that method claims are not, “as a category,  never exhaustible.” The “authorized sale” rule is derived from the holding of United States v. Univis Lens Co., a 1942 case that is the last patent exhaustion case decided by the Supreme Court before Quanta.
Since all patents that embody the invention are exhausted by a sale, the value of multiple forms of claiming, such as separate component, system, and method patents, is diminished. Quanta leaves open the possibility of enforcing additional restrictions by contract, but the case does not address the permissible scope of such restrictions.
II. Executive Summary
- Patent exhaustion is triggered by an authorized sale of a component that substantially embodies a patent. Once patent rights are exhausted, a patentee cannot control subsequent sale or use of the article, nor can it charge additional royalties.
- A component can substantially embody a patent without meeting all of the limitations of the patent claims.
- The sale of a single article may exhaust the claims of multiple patents.
- A substantial embodiment is a component that has “no reasonable use” other than to be combined into the infringing configuration and where the additional elements of the patent claim are “common and noninventive.”
- A sale is authorized if its completion does not breach an agreement between the seller and the patentee.
- Method or process claims are subject to the same rules of patent exhaustion as other types of claims; the sale of an article can also exhaust method claims.
- The case leaves open the possibility that parties may enforce additional restrictions on downstream use or sale through contractual agreement.
LG Electronics, Inc. (“LGE”) owned a portfolio of computer-technology patents. The portfolio contained patents that claimed individual components such as microprocessors, combinations of microprocessors, buses , and other components, as well as methods of managing bus access and cache memory. It licensed the entire portfolio to Intel Corporation. While Intel was licensed to make, use, and sell products that practiced any patent in the portfolio, the license stipulated that third parties who purchased from Intel or LGE were not authorized to combine the purchased components with other components obtained elsewhere. A separate agreement (the Master Agreement) required Intel to notify its customers that they were not licensed to combine “an Intel product with any non-Intel product.”
Quanta Computer, one of Intel’s customers, “purchased microprocessors and chipsets from Intel and received the notice required by the Master Agreement.” Quanta then built computers including memory and buses purchased from non-Intel sources. LGE brought a patent infringement suit against Quanta. It asserted violation of three patents containing combination and method claims, which could be infringed only by the computers built by Quanta and not by the Intel components alone.
The district court granted in part Quanta’s motion for summary judgment on the grounds of patent exhaustion. The district court held that the sale of the microprocessors exhausted LGE’s patents on combination claims that included those microprocessors. Relying on its interpretation of Univis Lens, the court held that “the patent exhaustion doctrine applies to the sale of unpatented items that have no other function but as components in a finished, patented device.”
The district court agreed with LGE that “the patent exhaustion doctrine requires an unconditional sale.” The district court also agreed with LGE that “it is entitled to impose conditions on the sale of its patented products or the essential components of its patented products, if it chooses.” Neither of these safe harbors protected LGE, however. The district court stated that “the mere fact that LGE is entitled to impose conditions on the sale of the essential components of its patented products does not mean that it actually did so.” The notice Intel sent to its customers pursuant to the Master Agreement was “not sufficient to transform what would otherwise be the unconditional sale of the microprocessors and chipsets into a conditional one.” The district court subsequently held, however, that the patents’ method claims were not exhausted by Intel’s sales.
The Federal Circuit affirmed the district court’s holding that the method claims were not exhausted, but reversed on the system claims. The Federal Circuit stated its rule that patent exhaustion requires an unconditional sale. “The patent exhaustion doctrine, commonly referred to as the first sale doctrine, is triggered by an unconditional sale.” “This exhaustion doctrine, however, does not apply to an expressly conditional sale or license.”
The Federal Circuit’s conditional sale doctrine originated in Mallinckrodt, Inc. v. Medipart, Inc. In that case, the patentee marked a medical device with a “Single Use Only” restriction, and the device’s instructions directed the user to dispose of it as biohazardous waste after a single use. The patentee brought an infringement suit against a company that refurbished the devices. The Federal Circuit vacated the district court’s dismissal on patent exhaustion grounds, remanding to determine whether “the sale of the [device] was validly conditioned under the applicable law such as the law governing sales and licenses, and if the restriction on reuse was within the scope of the patent grant or otherwise justified.” If so, “then violation of the restriction may be remedied by action for patent infringement.” Subsequently, in B. Braun Med. Inc. v. Abbott Labs., the Federal Circuit reaffirmed its view that express conditions accompanying a sale or license are generally upheld unless they “impermissibly broaden the physical or temporal scope of the patent grant with anticompetitive effect.”
Applying this precedent, which is highly receptive to finding that a conditional sale has overridden the patent exhaustion doctrine, the Federal Circuit swiftly disposed of the district court’s conclusion that Intel’s sales were not conditional. First, the court noted that the LGE-Intel license “expressly disclaims granting a license” to Intel’s customers who combine components from Intel and other sources. Second, Intel complied with the license’s requirement that it notify its customers of this limitation. The Federal Circuit’s view that the parties may freely contract around patent exhaustion, coupled with its conclusion that Intel’s notice was sufficient to render its sales conditional, resolved the patent exhaustion issue in LGE’s favor.
IV. Supreme Court Proceedings
The Supreme Court reversed the Federal Circuit, holding that Intel’s authorized sale of microprocessors and chipsets exhausted LGE’s patent rights to both the system and method claims asserted against Quanta. Applying decades-old Supreme Court precedent rather than more recent Federal Circuit modifications to the patent exhaustion doctrine, the opinion states that patent exhaustion is a “longstanding doctrine” that “provides that the initial authorized sale of a patented item terminates all rights to that item.”
The Court received extensive briefing from the parties and various amici on exhaustion of method claims, the first sale doctrine, implied licenses, and the economic effects of allowing (or prohibiting) downstream restrictions on sale and use of patented goods. The Solicitor General, on behalf of the United States, argued in support of Quanta that “the first-sale doctrine has evolved in the Federal Circuit in a manner that is at odds with [the Supreme] Court’s precedents.” In support of LGE, the American Intellectual Property Law Association argued that permitting “a patentee, with adequate notice” to “require separate licenses at various stages . . . . create[s] market efficiencies [that] allow for the appropriate and proper exploitation of intellectual property rights.” The Court firmly sided with the Solicitor General.
A. Supreme Court Precedent
In rendering its opinion, the Court first discussed cases from the late nineteenth and early twentieth centuries that prohibit post-sale control by the patentee. In Adams v. Burke the Court dismissed a patent owner’s attempt to enforce geographic restrictions imposed on a licensee against a third-party purchaser. In Motion Picture Patents Co. v. Universal Film Mfg. Co., the Court held that a patentee could not require the purchaser of a patented film projector to show only film made under a patent held by the same company.
The Supreme Court’s opinion discussed Univis Lens at considerable length. In Univis, the government challenged a patentee’s licensing and price maintenance scheme on patents to multifocal eyeglasses. Univis Lens Company (the “Lens Company”) owned “a number of patents . . . relating to multifocal lenses.” It organized a subsidiary, Univis Corporation (the “Corporation”) to which it transferred the patents. The Corporation in turn “license[d] the Lens Company to manufacture lens blanks and to sell them to designated licensees of the Corporation” in exchange for a royalty. The blanks were covered by the “claims of some one of the Corporation’s patents.” As well as licensing its parent company, the Corporation also created three classes of licensees who could purchase the lens blanks.
Univis Corporation admitted that “the invention of only a single patent is utilized in making each blank and finishing it as a lens.” Accordingly the Univis Court “put to one side questions which might arise if the finisher of a particular lens blank utilized the invention of some patent other than the patent which was practiced in part by the manufacture of the blank.” “We assume . . . without deciding, that the present patent is not fully practiced until the finishing licensee has ground and polished the blank so that it will serve its purpose as a lens.” The Court further “assume[d] . . . that sale of the blanks by an unlicensed manufacturer to an unlicensed finisher for their completion would constitute contributory infringement by the seller.” The Court reinforced this point by stating that upon the “sale of the blank . . . to a finisher, the only use to which it could be put and the only object of the sale is to enable the latter to grind and polish it for use as a lens by a prospective wearer.”
The Univis Court stated the first sale doctrine as follows: “Upon familiar principles the authorized sale of an article which is capable of use only in practicing the patent is a relinquishment of the patent monopoly with respect to the article sold.” Therefore, “[s]ale of a lens blank by the patentee or by his licensee is thus both a complete transfer of ownership of the blank, which is within the protection of the patent law, and a license to practice the final stage of the patent procedure.” “In the present case the entire consideration and compensation for both is the purchase price paid by the finishing licensee to the Lens Company.”
According to Univis, surrendering the patent monopoly also surrendered the power to control the downstream conditions of sale: “[t]he patentee may surrender his monopoly in whole by the sale of his patent or in part by the sale of an article embodying the invention.” “But the sale of it exhausts the monopoly in that article and the patentee may not thereafter, by virtue of his patent, control the use or disposition of that article.” Resale price restrictions were thereby brought into the ambit of the Sherman Act.
B. Application of Univis to the Quanta – LGE Facts
1. Method Claims Are Treated Equally to System Claims
The Quanta Court first held that “[n]othing in this Court’s approach to patent exhaustion supports LGE’s argument that method patents cannot be exhausted.” It agreed that “a patented method cannot be sold in the same way as an article or device.” The Court went on to conclude that “methods may nonetheless be ‘embodied’ in a product, the sale of which exhausts patent rights.” The Court stated that the patent exhaustion doctrine would be “seriously undermined” if method claims could not be exhausted. Clever drafting, thought the Court, “could shield practically any patented item from exhaustion” unless all types of claims were subject to exhaustion.
2. A Product Must Embody a Patent to Trigger Exhaustion
The Court next “consider[ed] the extent to which a product must embody a patent in order to trigger exhaustion.” It rejected each of LGE’s attempts to distinguish Univis Lens, and held that “[w]e agree with Quanta that Univis governs this case.” The Court refused to limit Univis Lens to products that “contain all the physical aspects needed to practice the patent,” or to situations in which both the article sold and the finished article are covered by only a single patent.
The lens blanks in Univis Lens were “without utility until they were ground and polished as the finished lens of the patent.” “Here, LGE has suggested no reasonable use for the Intel Products other than incorporating them into computer systems that practice the LGE patents.” Thus, the facts were similar in both cases. Further, both the lens blanks and the microprocessors “constitute a material part of the patented invention and all but completely practice the patent.”
The fact that the patent claimed a microprocessor in combination with other elements was completely irrelevant to the analysis: “the only step necessary to practice the patent is the application of common processes or the addition of standard parts. Everything innovative about each patent is embodied in the Intel Products.” “In each case the final step to practice the patent is common and noninventive: grinding a lens to the customer’s prescription, or connecting a microprocessor or chipset to buses or memory.”
The Court also rejected LGE’s argument that exhaustion could not apply because the microprocessor and the combination claims that included the microprocessor were the subject of separate patents. “The sale of a device that practices patent A does not, by virtue of practicing patent A, exhaust patent B. But if the device practices patent A while substantially embodying patent B, its relationship to patent A does not prevent exhaustion of patent B.”
Although combination patents have often been described as having a novelty residing in the combination of elements, rather than in any single element, the Court went on to characterize such patents as a special kind of combination. Aro Mfg. Co. v. Convertible Top Replacement Co., the seminal case on the repair-reconstruction doctrine, stated that combination patents “cover only the totality of the elements in the claim so that no element, viewed separately, is within the grant.” The Quanta Court distinguished this statement as “specific to the context in which the combination itself is the only inventive aspect of the patent.” The inventive aspect of the patents-in-suit, by contrast, “is included in the design of the Intel Products themselves and the way these products access the memory or bus.” Since the microprocessors lacked utility until built into the patented combination, and because they exhibited the inventive aspects of the claims, the Intel components embodied the patented invention.
3. Only Authorized Sales Trigger Exhaustion
The opinion then addressed whether Intel had the authority to sell to Quanta: “Exhaustion is triggered only by a sale authorized by the patent holder.” The Court rejected LGE’s argument that there was no authorized sale because the license agreement “does not permit Intel to sell its products for use in combination with non-Intel products.” The Court distinguished cases such as General Talking Pictures Corp. v. Western Elec. Co., in which “exhaustion did not apply because the [licensee] had no authority to sell” products into a prohibited field of use. The licensee “could not convey to petitioner what both knew it was not authorized to sell.”
In this case, “neither party contends that Intel breached the agreement” to provide notice to its customers of the all-Intel restrictions. Further, “Intel’s authority to sell its products . . . was not conditioned on the notice or on Quanta’s decision to abide by LGE’s directions in that notice.” The language “disclaim[ing] any license to third parties” was dismissed as “irrelevant because Quanta asserts its right to practice the patents based not on implied license but on exhaustion.” “And exhaustion turns only on Intel’s license to sell products practicing the LGE patents.”
The Court left open the possibility that “the authorized nature of the sale to Quanta does not necessarily limit LGE’s other contract rights. . . . we express no opinion on whether contract damages might be available even though exhaustion operates to eliminate patent damages.”
V. Implications For Practitioners
A. Exhaustion Is Determined By Patentee/Licensee Relationship
After Quanta, analysis of patent exhaustion focuses on a single transaction, that between the patentee and the licensee. Since that is the case, language within a license attempting to restrict a third party purchaser’s rights that does not also restrict the licensee’s rights will be ineffective, just as the language in the LGE-Intel license that purported to deny a license to third parties was not given effect. Although Quanta does not expressly address the Mallinckrodt’s conditional sale rule, application of Quanta’s authorized sale rule prohibits a patentee from imposing conditions on use where the sale itself is unrestricted.
Extending patent exhaustion to method claims reduces a patentee’s options only slightly. It is important to note again that Quanta did not address the separate doctrine of implied license, which is another means by which a downstream purchaser can acquire patent rights. Under implied license, rights to apparatus and method claims have remained closely linked. For example, Met-Coil Systems Corp. held that “unrestricted sales of a machine useful only in performing [a] claimed process . . . plainly indicate that the grant of a license should be inferred.”
Quanta reduces the ability of a patentee to receive royalties from multiple points in a chain of manufacture. This will be particularly so when, as in this case, a single component of a combination claim is found to exhibit all of the inventive aspects of the combination. A patentee who holds patents on a component, a combination, and a method will have to establish a single royalty-bearing transaction if the licensed component is found to “substantially embody” the combination and method claims.
Even after Quanta, it appears that a patentee is still free to impose restrictions on its licensee’s ability to sell in particular geographic areas or to particular fields of use. The Quanta Court distinguished the license in General Talking Pictures, which contained such restrictions, from the LGE-Intel license, but did not appear to limit the holding of General Talking Pictures. The Solicitor General, although arguing for reversal and a return to the Univis Lens standard, did not challenge the propriety of enforcing such field of use restrictions through patent infringement suits.
Thus, there remains the possibility that a patentee could license one entity to enter a high-value field of use, with an appropriately high royalty, while restricting another licensee to a lower-value field of use, and be able to prevent third parties from purchasing from the low-price licensee and then entering the high-value field of use. Since neither party has a right to sell, but only a right to use, a patentee may able to obtain higher royalties from the users for which the patent is more valuable.
B. Not All Components Substantially Embody a Patent
Quanta limits exhaustion to sales of components that embody a patent. On the facts of the case, the patented microprocessors were held to embody both system and method claims that incorporated them because (1) the microprocessors had “no reasonable use” other than to be incorporated into computer systems that practiced the asserted patents, and (2) “the final step [of adding memory or a bus] to practice the patent is common and noninventive.”
It may be possible to avoid exhaustion if one of these factors is absent. For example, if a component has other reasonable uses than to be incorporated into the asserted patents, then its sale may not exhaust patents that include that component in combination. It remains unclear whether the “embodies the patent” standard is met only by components whose unauthorized sale would constitute contributory infringement, or whether the “no reasonable use” factor differs from contributory infringement’s requirement that such articles must lack “substantial noninfringing use.”
A patentee may also argue that a combination patent is not exhausted by sale of a component because the addition of other elements has an innovative aspect such that they are not simply “common and noninventive.” This argument may be available if a combination claim contains two or more inventive components. It may also be available if the novelty resides in the entire combination, even though no particular element is inventive. Quanta appears to recognize certain types of combinations may fall into this category, as its discussion of Aro shows.
C. A Patentee May Enforce Additional Restrictions by Contract
Quanta leaves open the possibility of enforcing additional restrictions on downstream use or sale by contract, rather than by patent law. Patentees may try to incorporate many characteristics of patent law into such contracts, such as entitlement to attorneys’ fees, availability of enhanced damages, or entitlement to injunctive relief. Given the Supreme Court’s willingness to apply its older precedents to contemporary patent law disputes, it is likely to follow its earlier statement in Keeler v. Standard Folding Bed Co. that such breach of such a contract does not also give rise to a cause of action for patent infringement.
Enforcement of such contracts may be difficult for a number of reasons, such as state-law hostility to liquidated damages provisions. Further, contractual arrangements, particularly between competitors or where the patentee has a dominant market position, are more likely to receive antitrust scrutiny than patent infringement suits would receive.
D. Both Patentee’s and Purchasers Should Remain Alert to Implied Licenses
Implied license is an equitable doctrine that requires examining the bilateral relationship between the patentee and its purchasers. It can arise by “by acquiescence, by conduct, by equitable estoppel, (estoppel in pais) or by legal estoppel.” The most significant distinction from patent exhaustion is that a patentee can effectively disclaim an implied license at the time of the transaction. Patentees may continue to include such disclaimers in their express licenses and sales, while purchasers and licensees who are presented with such disclaimers may wish to clarify their scope before entering into a transaction.
E. Questions Remain Concerning a Patentee’s Ability to Authorize Sales of Components that Would Contributorily Infringe
There is an arguable tension in Quanta and the law of contributory infringement. Quanta holds that sale of a component that embodies an invention can exhaust the entire patent. However, Section 271(d) provides that “no patent owner otherwise entitled to relief for infringement or contributory infringement of a patent shall be denied relief” for engaging in a number of activities. This section expressly permits the following two acts by a patentee without prejudice to relief for infringement: (1) “deriv[ing] revenue from acts which if performed by another without his consent would constitute contributory infringement”; or (2) “licens[ing]  another to perform acts which if performed without his consent would constitute contributory infringement.” If components that embody an invention are also components whose unauthorized sale would be contributory infringement, Quanta’s exhaustion rule would seem to entirely vitiate the patentee’s safe harbors to license component sales under this section.
F. Quanta Does Not Address Its Application to Biotechnology
Quanta confined its discussion to precedent and its application to the facts of the LGE license. It did not address, even in dicta, the application of its patent exhaustion rule to biotechnology. In its amicus brief, the Biotechnology Industry Organization pointed out that the rights to make and use an invention are granted separately by the patent laws, and that acquisition of the right to use does not ordinarily confer a right to make a patented invention as well. The brief goes on to state that “[p]reserving the rule that patent exhaustion law does not extend to the making of patented products is of critical importance to the biotechnology industry.” Since many biotechnology inventions are self-replicating, “[t]he line between using and making can be a fine one.”
In addressing the distinction between using and making a patented article, Quanta tersely rejected LGE’s arguments that patent exhaustion “does not apply to postsale restrictions on ‘making’ an article.” It states that “this is simply a rephrasing” of LGE’s other arguments. The Court saw little difference between using and making in this case: “making a product that substantially embodies a patent is, for exhaustion purposes, no different than making the patented article itself.”
Such a sweeping pronouncement is troubling if applied without modification to biotechnology inventions. Although some litigants will likely try to apply Quanta to self-replicating inventions, the better view is that Quanta’s elimination of the distinction between making and using is limited to “the addition of standard parts” to form a claimed combination, and not making copies of a patented invention, whether self-replicating or not.
Quanta is another in the recent line of unanimous Supreme Court reversals of Federal Circuit opinions. The case sets out an “authorized sale” test for patent exhaustion. An authorized sale exhausts patent rights in the article sold, as well as combination claims that are embodied by the article sold and method claims that are necessarily practiced in using the article. The decision states that a patentee may attempt to enforce downstream restrictions by contract, but does not elaborate on the enforceability of such contractual restrictions.
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