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les Nouvelles April 2017 Article of the Month
Exhaustion v. Non-Exhaustion— Deciphering The Federal Circuit’s Lexmark Decision And Its Implication On Technology Transactions

Jiang BianJiang Bian

Shartsis Friese LLP
Associate
San Francisco, CA, USA

The Decision And Issues On February 12, 2016, the United States Court of Appeals for the Federal Circuit issued its en banc (where a case is heard before all the judges of a court) decision Lexmark International, Inc. v. Impression Products, Inc., which confirmed that, despite recent decisions of the United States Supreme Court supporting exhaustion of intellectual property rights after the initial sale, the Federal Circuit’s patent exhaustion jurisprudence (or so called, “patent non-exhaustion doctrine”) enumerated in its prior rulings, Mallinckrodt, Inc. v. Medipart, Inc., and Jazz Photo Corp. v. International Trade Comm’n, remains good law (at least before the Supreme Court decides to explicitly override the two decisions) with respect to the following two issues, respectively:

  1. whether accompanying product sales with lawful and clearly communicated restrictions could avoid patent exhaustion within such declared limits; and
  2. whether foreign sales authorized by the owner could exhaust the owner’s U.S. patent rights when patented products are shipped back to the United States.

This long-awaited decision has a significant impact on licensees and licensors and acquirers and sellers of intellectual property rights and creates traps for the unwary when structuring and negotiating technology transactions.

This Article intends to reconcile the holdings of the Lexmark decision and prior Supreme Court cases, taking into account the overarching legislative framework, and provide guidance on how to draft license, distribution, services or sales agreements to avoid unintended exhaustion or non-exhaustion of involved intellectual property rights.

Court Precedent And Statutory Framework

In the Quanta Computer, Inc. v. LG Electronics, Inc. case, LG Electronics had licensed Intel to make and sell microprocessors and chipsets that use LGE’s patents. The LGE-Intel license disclaimed that no license was granted “to any third party for the combination by a third party of Licensed Products…with [non-Intel products].” A separate master agreement between the parties required Intel to notify its downstream purchasers that the LGE-Intel license “does not extend, expressly or by implication, to any product that you make by combining an Intel product with any non-Intel product,” which Intel complied.

The disclaimer and notification clause, in the Supreme Court’s view, were not sufficient grounds to characterize this transaction as a conditional sale. In particular, the Supreme Court notes that “[n]othing in the License Agreement restricts Intel’s right to sell its microprocessors and chipsets to purchasers who intend to combine them with non-Intel parts.” Another factor considered by the Supreme Court is that even if Intel failed to adhere to the notice requirement in the master agreement, it would not result in a breach of the license agreement and Intel’s continuous rights to make, use, and sell the patented products was not expressly conditioned on providing such notice.

However, the Supreme Court did not try to address whether a conditioned sale may still avoid patent exhaustion after Quanta and, if so, what would be required for a sale to be validly conditioned. Therefore, some may interpret the Supreme Court’s 2008 decision in Quanta Computer, Inc. v. LG Electronics, Inc., to merely suggest that the straight sale, by or with the authority of the patentee (such as via an authorized licensee), of a patented product, gives the purchaser, or any subsequent owner, a right to use or resell that product in any way they like.

Relying on Quanta’s abstaining from addressing conditioned sales, the Federal Circuit held in Lexmark that its 1992 Mallinckrodt decision survived Quanta and that “a patentee, when selling a patented article subject to a single-use/no-resale restriction that is lawful and clearly communicated to the purchaser, does not by that sale give the buyer, or downstream buyers, the resale/reuse authority that has been expressly denied.” The Federal Circuit found that in the Lexmark case, the patent owner made it very clear in end-user agreements that all sales (no matter domestic or abroad) are subject to the following restriction: once used, the buyer must return the patented product to the owner only and may not transfer it to anyone else; therefore, such restriction is not abrogated by the patent exhaustion doctrine.

In the 2012 Kirtsaeng v. John Wiley & Sons, Inc. case, the Supreme Court recognized the viability of international exhaustion of copyright. As a result, copyright owners now may not assert their U.S. copyrights against importation and circulation of copies sold abroad as long as the original sales were authorized by the copyright owner. In contrast, in the 2001 Jazz Photo case, the Federal Circuit decided against international patent exhaustion and held that foreign sales cannot presumptively exhaust U.S. patentees’ rights in the United States. Some would suspect the Federal Circuit to reverse its course after the Supreme Court’s Kirtsaeng decision.

Standing behind its old wisdom and distinguishing Kirtsaeng as a copyright case, the Federal Circuit in Lexmark reaffirmed its Jazz Photo ruling that, in the patent realm, foreign sales of products covered by U.S. patents, even authorized by the patent owners, do not imply an authority to import such product to, and sell and use them in, the United States. Consequently, oversee purchasers of Lexmark’s patent product cannot resell it back to the United States (other than to Lexmark itself) because of the non-transfer restriction set forth in end-user agreements.

It is a fair question to ask why the seemingly similar doctrines may play out differently in the patent and copyright contexts. We have to keep in mind that the patent exhaustion doctrine is a principle developed by case laws, while the copyright exhaustion doctrine is codified in section 109(a) of the U.S. Copyright Act, which allows owners of lawfully made copies to sell such copies without the authority of the copyright holders. There is no counterpart to that provision in the U.S. Patent Act, giving courts more discretion in patent cases to strike a balance between patents’ monopoly and free competition.

Finally, to fully appreciate the impact of the Lexmark decision, it is also worth noting that the Federal Circuit currently has exclusive jurisdiction over all actions that include a complaint or compulsory counterclaim arising under the U.S. Patent Act. As a result, the decisions of the Federal Circuit in regard to the U.S. patent laws (such as Lexmark, Mallinckrodt and Jazz Photo), before reversed by the Supreme Court, are binding precedent throughout the United States. Other federal circuit courts, however, do not need to follow the Federal Circuit decisions in copyright cases (while, of course, are still bound by the Supreme Court precedent such as Kirtsaeng).

Takeaways

The current state of law after Lexmark can be summarized as follows: (1) in the absence of a controlling agreement, after the initial sale of a patented or copyrighted article, the owner’s intellectual rights with respect to that particular article generally is exhausted (i.e. the buyer is free to use or resell it); (2) when the controlling agreement is not entirely clear about exhaustion (for example, the agreement does not specify if a foreign sale exhausts the owner’s intellectual property rights in the United States), there is a strong pro-exhaustion presumption in the copyright context (in the prior example, the foreign sale exhausts the owner’s U.S. copyright on the sold article, even if the agreement is completely silent about that effect), and, in the contrast, a fair amount of jurisprudence against the swift exhaustion of the owner’s patent rights (in the prior example, the foreign sale does not presumptively exhaust any domestic patent, unless the agreement clearly states so); and (3) courts give considerable weight to the specific contract language when analyzing exhaustion issues.

Therefore, in the post-Lexmark era, it is important for technology-transfer practitioners to understand the types of intellectual property rights involved (e.g. patent vs. copyright) and carefully craft the corresponding agreements to achieve their goals. For licensors who want to maintain desired control over their patented products in the market, they should consider to clearly delineate the desired license restrictions and explicitly subject the license grant to licensees’ diligently enforcing the license restrictions against down-stream purchasers and providing advance and conspicuous notice of such restriction, and not just focus on timely payment of the required license fees. For buyers who believe they have negotiated full or partial exhaustion of the owner’s intellectual property rights on the purchased products, they should unequivocal state such effect in the controlling agreement.

Available at Social Science Research Network (SSRN) http://ssrn.com/abstract=2822339