Brief History of Patent Exhaustion

In 1853, the Supreme Court established the so called “patent exhaustion (or 1st sale)” doctrine in Bloomer v. McQuewan, 14 How. 539 (U.S. 1853), which limits patent holders’ rights against downstream 3rd party purchasers. In theory, once a patent holder has sold his or her patented article, the purchaser is free to use or sell that patented article free from any further claim by the patent holder. 20 years later, in 1873, the Supreme Court affirmed this theory in Adams v. Burke, 84 U.S. 453 (1873). In Adams v. Burke, Lockhard & Seelye owned, by assignment, all the right, title, and interest which the patent holders had in a certain patented coffin lid, in a 10-mile radius around Boston. Adams, also by assignment, was the owner of all other rights under the patent. Burke bought coffin lids from Lockhard & Seelye and used outside the 10-mile radius around Boston, in the town of Natick (17 miles from Boston). In response to Adams’ infringement claim, Burke pleaded that the patented coffin lids were purchased from Lockhard & Seelye without condition or restriction. The Supreme Court found that Burke, as a purchaser, “had acquired the right to use that coffin for the purpose for which all coffins are used”, and held that “in the class of machines… when they are once lawfully made and sold, there is no restriction on their use to be implied for the benefit of the patentee or his assignee or licensees.”

100 years later, in United States v. Univis Lens Co., 316 U.S. 241 (1942), the Supreme Court even extended the patent exhaustion doctrine to unfinished products. In United States v. Univis Lens Co., Univis Corp. granted Univis Lens a license to manufacture and distribute lens blanks to wholesalers, prescription retailers and finishing retailers. The license carried a $0.50 royalty. Univis Lens then sold the blanks to wholesalers and finishing retailers who would finish the lenses and sell them to customers. Univis Corp. then sought to restrict the sales by the wholesalers and finishing retailers to a fixed price, and its rationale for this was that the downstream finishers were practicing their patent too. Below is a flowchart that demonstrates the relationship between Univis Corp., Univis Lens, wholesalers and finishing retailers.

The Supreme Court found that Univis Corp. exhausted its right to restrict future sales of its products when it allowed Univis Lens to manufacture the lenses. This was because the only step required by the finishers was the application of standard practices. In the Court’s view, it was the upstream manufacturers who practiced the patents, not the finishers. "[W[here one has sold an uncompleted article which, because it embodies essential features of his patented invention, is within the protection of his patent, and has destined the article to be finished by the purchaser in conformity to the patent, he has sold his invention so far as it is or may be embodied in that particular article…. He has thus parted with his right to assert the patent monopoly with respect to it and is no longer free to control the price at which it may be sold either in its unfinished or finished for." United States v. Univis Lens Co., 316 U.S. 241, 250-51 (1942).

Nevertheless, in an effort to strengthen patent holders’ rights in early 1980’s following the formation of the Federal Circuit, the Federal Circuit, in the landmark case Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992), limited the “patent exhaustion” doctrine only to “unconditional sales”, and not to expressly conditional sales or licenses. As a result, the patent holder may condition sale of a patented article to a license agreement with a 3rd party with restrictions permitting the patent holder to enforce the patent against a downstream purchaser. As such, Mallinckrodt in effect nullified the patent exhaustion doctrine advanced by the Supreme Court in Bloomer, and allowed the patent holder to “contract around” the patent exhaustion doctrine to get compensate more than one royalty for a patented article.

In Mallinckrodt, the induced infringement action related to the use of a patented radioactive medical device in violation of a "single use only" notice that accompanied the sale of the device. Mallinckrodt sold its patented device to hospitals, which after initial use of the devices sent them to Medipart for servicing that enabled the hospitals to use the device again. Mallinckrodt claimed that Medipart induced infringement by the hospitals and itself infringed the patent. Below is a flowchart that demonstrates the relationship between Mallinckrodt, hospitals and Medipart.

In endorsing the "conditional sale" approach, the Federal Circuit stated that, "unless the condition violates some other law or policy (in the patent field, notably the misuse or antitrust law), private parties retain the freedom to contract concerning conditions of sale…. The appropriate criterion is whether Mallinckrodt’s restriction is reasonable within the patent grant [i.e., it relates to the subject matter within the scope of the patent claims], or whether the patentee has ventured beyond the patent grant and into behavior having an anticompetitive effect not justifiable under the rule of reason." Mallinckrodt, 976 F.2d 700, 708 (Fed. Cir. 1992) (emphasis added).

In 2008, the Supreme Court reconsidered the contemporary relevance of the patent exhaustion doctrine. In Quanta Comp. v. LG Electronics, 553 U.S. ___; 86 USPQ2d 1673 (June 9, 2008), the Supreme Court unanimously reaffirmed the patent exhaustion doctrine, holding that patent holders have little or no power to restrict what a purchaser does with a product after the first sale. Quantaand its aftermath will be discussed in detail as follows.

Background of Quanta

LG possessed three patents addressing optimization of memory access by a computer processor (the “LG Patents”). The patents included claims to a system for ensuring retrieval of current data, a system for the ordering of read and write requests, and a system for managing data traffic on wires connecting computer components (known as a “bus”), as well as methods claims for the use of the system. LG entered into a licensing agreement with Intel, authorizing Intel to practice the system claims (the “License Agreement”). However, LG stipulated that Intel give notice to its customers that the license did not extend to products made by combining an Intel chip with a non-Intel product, but did not otherwise limit the downstream sale of the Intel chips. This stipulation was contained in a separate agreement from the licensing agreement, the “Master Agreement,” and explicitly stated that a breach would not affect the License Agreement.

Quanta Computer purchased processor chips from Intel and built computer systems incorporating the chips. Intel provided Quanta with the required notice and Quanta proceeded to construct computer systems combining the Intel chips with non-Intel components (such as memory, hardware busses, etc). LG then sued Quanta, alleging infringement of the LG Patents.

The District Court initially ruled in favor of Quanta, granting summary judgment on the grounds that the doctrine of patent exhaustion prevented LG from asserting its rights to the patents against Quanta. On reconsideration, the District Court denied summary judgment for Quanta on the grounds that the LG Patents contained method claims not covered by the licensed system claims. The Federal Circuit affirmed-in-part and reversed-in-part, agreeing with the District Court that the doctrine of patent exhaustion does not apply to method patents (patents claiming how to make or use a product, as opposed to the product itself). The Federal Circuit also noted that LG did not license Intel to sell the product for the purposes of combination with non-Intel products such that there was no authorized sale.

Quanta filed a petition for certiorari, asking the Supreme Court to determine whether the Federal Circuit erred by holding that LG's patent rights were not exhausted by its license agreement with Intel Corporation, and Intel's subsequent sale of product under the license to Quanta.

Supreme Court’s Holding

On June 9, 2008, the Supreme Court unanimously overruled the Federal Circuit’s decision which had held the method patents were not within the scope of the patent exhaustion doctrine, and held that LG’s sale to Intel, who then sold to Quanta, exhausted LG’s patent rights against a downstream purchaser.

In particular, the Supreme Court began with a review the longstanding doctrine of patent exhaustion, which provides that the initial authorized sale of a patented item terminates all patent rights to that item. Quanta, 86 USPQ2d at 1677; see Bloomer v. McQuewan, 14 How. 539 (U.S. 1853). “Where a person has purchased a patented machine of the patentee or his assignee, this purchase carries with it the right to the use of that machine so long as it is capable of use.” Adams v. Burke, 17 Wall. 453 (U.S. 1873). The Court further reviewed their last decision on the doctrine of patent exhaustion in United States v. Univis Lens Co., 316 U.S. 241 (1942) and reaffirmed the holding that the sale of the lens blanks exhausted the patents on the finished lenses. As summarized by the Court, Univis stands for the proposition that “the traditional bar on patent restrictions following the sale of an item applies when the item sufficiently embodies the patent—even if it does not completely practice the patent—such that its only and intended use is to be finished under the terms of the patent.” Quanta, 86 U.S.P.Q.2d at 1678.

LG had argued, and the District Court and Federal Circuits had held, that the doctrine of patent exhaustion does not apply to method claims. In contrast, Quanta argued that both the Supreme Court and the Federal Circuit had applied exhaustion to method claims in the past.

The Supreme Court recognized that it has “repeatedly held that method patents were exhausted by the sale of an item that embodied the method.” Quanta, 86 USPQ2d at 1679. For example, the Court noted that in Ethyl Gasoline Corp. v. United States the sale of a motor fuel produced under one patent also exhausted the patent for a method of using the fuel in combustion motors. 309 U.S. 436, 446, 457 (1940); Quanta, 86 U.S.P.Q.2d at 1679. Moreover, the Supreme Court pointed out that excluding method claims from the doctrine of patent exhaustion would seriously undermine the doctrine. If such an exclusion were allowed, patentees seeking to avoid exhaustion would seek to claim a method instead of an apparatus. Converting an apparatus claim into a method claim is relatively simple, so the effect of such an exclusion would effectively neutralize the doctrine. The Court further did not see a significant difference between method and apparatus claims that would require an exclusion, and refused to categorically exclude method claims from the doctrine of patent exhaustion when there is a sale of a device covered by corresponding apparatus claims.

Having determined that exhaustion applies to method claims, the Court then turned to discussing the extent to which a product must embody a patent in order to trigger exhaustion. Quanta argued that the Court should apply Univis, as the Intel chips here played an analogous role to the lens blanks in that case. LG sought to distinguish Univis on three grounds: Univis should be limited to physical aspects, the lens blanks and final lenses in Univis were covered by the same patent whereas the Intel chips and systems incorporating the chips were covered by different patents, and that Univis shouldn’t apply as the components here represented parts of a combination patent.

The Supreme Court agreed with Quanta, and applied Univis to the facts of the case. As with the lens blanks in Univis, the only reasonable and intended use of the Intel chips was to practice the LG Patents, and the chips sufficiently embodied essential features of the patented invention. Quanta, 86 USPQ2d at 1680-81. Univis held that “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.” Univis at 249. The Court held that an incomplete article substantially embodies a patent if the only remaining step necessary to fully practice the patent is the application of common processes or the addition of standard parts. Quanta, 86 USPQ2d at 1680-82. Everything ‘inventive’ about the patent is included in the Intel chips; all that remained for Quanta to do was put it to use by attaching the chips to the standard system components it was designed to use.

Intel’s chip practiced the LG Patents, like the lens blanks in Univis. Quanta simply finished the product by attaching the required components to it, like the finishing retailers polishing the lens.

The Court rejected LG’s attempts to distinguish Univis. With regards to limiting the holding to physical changes, the Court held that the important component is the nature of the final step, not whether it consists of adding or deleting material. When the final step to completely practice the patent is common and non-inventive (i.e. grinding the lens or attaching standard components to the processor chip), the incomplete article substantially embodies the patent.

As for LG’s argument that multiple patents covered different elements of the system, the Court agreed with the general principle that practicing one patent should not exhaust another patent. However, as the Court concluded, the Intel chip substantially embodied the patent LG sought to assert against Quanta and exhausted LG’s rights through the authorized sale of the chip. While Intel’s chip practiced many other patents fully, there is no reason why it could not also practice (substantially embody) the LG patent in question. The Court dismissed LG’s combination patent argument as it did not see the combination of components to be the inventive step here.

The Court noted that a patentee’s rights are exhausted against a buyer when the patentee sells a patented product to him. Further, a patentee’s rights are exhausted against parties who later buy the product from that buyer, provided the patentee authorized the buyer to sell the product. Here, the Court found that LG authorized Intel to sell chips practicing LG’s patents. Even though LG required Intel to provide a notice that no license would extend to parties combining the Intel chip with non-Intel parts, Intel was otherwise unconditionally authorized to sell the chips. There was no breach by Intel as Intel did provide the required notice to LG, thus the sale was authorized per the contract.

LG asserted that Quanta possessed no license to practice its patents, but Quanta argued exhaustion of the patents by sale, not that it was licensed to practice the patent. The existence of exhaustion turns solely on Intel’s right to sell the patented invention, and the license agreement between Intel and LG makes it clear that Intel’s sale was authorized. Because the Court found that it is the incomplete article (the Intel chips) that practices the patent, and not the final product (Quanta’s computer system), the Court found LG’s claims barred by exhaustion. Intel practiced the patent, not Quanta. Quanta’s combination of the Intel chip was simply standard finishing which did not amount to “making” a patented article.

Aftermath

While finding the LG patents were exhausted through Intel's authorized sale, the Court specifically noted that its opinion is directed only at patent law. “The 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 post-sale use of the article.” Quanta, 86 USPQ2d at 1682. The Court also noted that LG is only barred from seeking damages under patent law, but declined to extend their decision to the contractual consequences. Quanta, 86 USPQ2d at 1682 n. 7. The Court’s dicta seemed to suggest that a patentee’s restitution in similar situations to this lies in the terms of the licensing contracts, with damages being limited to contractual damages.

Quanta represents a significant limitation to the exhaustion doctrine as it removes one possible set of remedies (i.e., those based upon patent infringement) for unlicensed use of a patented product. Through Quanta, the Court clarifies that the sale of a product will remove any patent-based infringement theory to the extent that the patented product has no other purpose but to be incorporated into a final product or a non-inventive use of the product in a particular system. While seemingly beneficial to end users, the Court does make clear that not all remedies are removed. Instead, the Court specifically notes that breach of contract remedies should be available. Thus, while treble damages may not be available due to patent exhaustion, specific performance, damages and other breach of contract claims would survive. Moreover, given the Court's emphasis on the fact that the License Agreement did not prohibit the sale of the chips where the customer combined the chips with non-approved products and only required a notice to be provided with the chips, it would be expected that licensors may attempt to cure this deficiency to ensure that the contract does not extend to such situations (thereby emphasizing the unauthorized nature of the initial sale). As such, it would be expected that patent owners will increasingly look to licensing restrictions to govern end user use of patented items, and will be less reliant on merely selectively licensing patents.