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The Exhaustion Theory Is Not Yet Exhausted Part 3

Erik VerbraekenErik Verbraeken

Johnson Controls, Directeur, Juridique, France, & Sr. Legal Counsel EMEA, Colombes, France

Year 2013 has been rich in the issuance of various court decisions, from the Supreme Court to the District Courts, that provide further guidance on the application of the intellectual property exhaustion doctrine (a.k.a. the "first sale" doctrine) to sales of products made by unauthorized third parties.

Without giving an exhaustive overview of all judicial cases that may have been tried in 2013, this article will focus on the following six decisions: (1) Kirtsaeng vs. John Wiley Inc. (Supreme Court March 19, 2013), (2) Bowman vs. Monsanto (Supreme Court May 13, 2013), (3) Capitol Records vs. Redigi (NY District Court March 30, 2013, (4) Keurig vs. Sturm Foods (Federal Circuit October 17, 2013), (5) Lifescan Scotland vs. Shasta Technologies (Federal Circuit November 4, 2013), and (6) Tessera vs. ITC (Federal Circuit May 23, 2011). In addition, this article will comment on these decisions from a EU perspective, where in some instances similar, but in other cases radically different decisions have been given.

1. Kirtsaeng vs. John Wiley (U.S. Supreme Court March 19, 2013, 568 U.S. ___, 2013)

Since the Supreme Court has given its patent exhaustion milestone decision in Quanta vs. LG Electronics in 2008, 2013 has provided the opportunity for a further ground breaking decision in the area of copyright in a matter opposing Mr. Supap Kirtsaeng, a Thai student studying in the USA, against John Wiley & Sons, a global publishing company that specializes in academic publishing. Since this decision has also been discussed in the John Paul & Brian Kacedon section of "Recent U.S. Decisions" in les Nouvelles of June 2013, I will only give a summary of the essential facts and findings in this article.

Kirtsaeng vs. John Wiley centered around the question whether the U.S. copyrights owned by John Wiley on textbooks that it publishes on a worldwide basis, can be opposed against an individual (or corporation) that purchases these books in a foreign jurisdiction in order to import and sell the latter in the USA. In other words, are U.S. copyrighted works subject only to a national exhaustion rule or to an international exhaustion rule?

In a nutshell, the Supreme Court ruled in favor of Mr. Kirtsaeng (and hence, in favor of the international exhaustion of copyright) on the basis of the following findings:

(a) relying on a textual interpretation of the relevant provisions of the Copyright Act, also in light of the historical and contemporary statutory context, the Court found no foothold in the language of these provisions supporting the argument of John Wiley that the "first sale doctrine" should not apply to copyrighted works lawfully made abroad; "lawfully made under this title" as mentioned in section 109(a) of the Copyright Act does not restrict the scope of this article geographically.

(b) besides this textual interpretation, the Court also addresses the "parade of horribles" that would be the result of a geographical limitation, by pointing out the "intolerable consequences" that would result for the marketplace when the "first sale" doctrine would be limited to "made in the USA" works only; foreign manufactured copyrighted products that, today but also tomorrow, represent high volume commercial transactions ("retailers tell us that over $2.3 trillion worth of foreign goods were imported in 2011") would be barred from importation into the USA unless specific permission from the copyright holder would be obtained, and would thus be barred from further second-hand sales within the USA.

The Kirtsaeng decision is not only of paramount importance from a legal perspective in that it applies the international exhaustion doctrine not only to products manufactured domestically for which the first sale occurred abroad (Quality King Distributors vs. L'anza Research), but also to products manufactured abroad; it may also create shockwaves from a economic perspective in that international exhaustion will undermine market differentiation practices where companies adjust their prices to what the local market is anticipated to bear. As mentioned in the dissenting opinion to the Supreme Court decision, "To protect their profit margins in the U.S. market, copyright owners may raise prices in less developed countries or may withdraw from such markets altogether"— raising the specter that companies may abandon sales in low profit countries when they fear that such sales may later cannibalize their operations in higher profit countries.

Also, this decision may have significant consequences from a commercial perspective because "the natural market response after Wiley would be for publishers to turn to digital distribution, where publishers may retain full control under prevailing digital licensing models" (cf. "Kirtsaeng vs. Wiley Incentivizes Digital Distribution" from Ilaria Maggioni in les Nouvelles of December 2013).

Finally, this decision demonstrates a watershed between the approaches to international exhaustion within the U.S. on the one hand and within the EU on the other hand. As the dissenting opinion of judge Ginsburg puts forward, international exhaustion is a "highly contentious trade issue" and the Court's position risks undermining the U.S. credibility on the world stage, by issuing a ruling that is at odds with the stance taken by U.S. authorities in international trade negotiations on this subject-matter.

Indeed, the Court of Justice of the EU has ruled against international exhaustion for trademark rights in the Silhouette decision of July 16, 1998, and more in particular for copyrights in the Laserdisken decision of September 12, 2006, relying on the objective of the common market pursued by the Member States under the EU Treaty, i.e. to safeguard the functioning of the internal market, implying that a situation in which some Member States could provide for international exhaustion while others provide for Community exhaustion only would "inevitably give rise to barriers to the free movement of goods and the freedom to provide services." Exhaustion of rights is accepted within the EU as of regional (i.e. between EU Member States) application only, in order to foster the unity and integrity of the internal market. Worldwide international exhaustion on the other hand is a commercial policy instrument, and as the Advocate General Jacobs alluded in the Silhouette decision, should be part of a multilateral trade arrangement based on reciprocity.

Whereas the Kirtsaeng decision has now unconditionally embraced the international exhaustion doctrine for copyrights, the question remains whether the same logic applies to patent rights and trademark rights … and any other IP rights in general. In other words, can this decision of the Supreme Court automatically be extrapolated to the trademark and patent context? For trademarks, it is generally recognized that trademarked goods may be imported if they emanate from a foreign affiliated company of the brand owner and the goods do not differ materially from those marketed in the United States. However for patents, until now, the Federal Circuit has held that patent rights are only exhausted through domestic sales, excluding the application of this doctrine to foreign sales that are subsequently imported into the USA: Jazz Photo Corp. v. International Trade Commission (Fed. Cir. 2001); Fujifilm Corp. v. Benun (Fed. Cir. 2010).

Will Kirtsaeng consequently be a precursor for the reversal of the "national-only" patent exhaustion theory for patents? On the one hand, it can be argued that whereas the international exhaustion has been accepted for trademarks and for copyright, there is no compelling reason why it should not be accepted for patent rights. In addition, the practical issues put forward by the Supreme Court in Kirtsaeng for copyrighted works apply likewise for patented products: "automobiles, microwaves, calculators, mobile phones, tablets and personal computers contain copyrightable software programs" (like they will probably contain patented compounds and parts) and "a geographical interpretation would subject many, if not all, of them to the disruptive impact of the threat of infringement suits"—identical issues that in all likelihood will exist for patented goods.

On the other hand however, the copyright related ruling of the Supreme Court in Kirtsaeng was anchored on the statutory and historical interpretation of Section 109(a) of the Copyright Act, whereas the patent exhaustion doctrine finds no basis in any U.S. statute, and has found its origin in judicial constructions since the first case of Adams vs. Burke in 1873. The Supreme Court has recently been offered an opportunity to confirm or infirm its holdings within the patent context in the wake of the Kirtsaeng decision through a writ for certiorari in the matter of Ninestar Technology Co. v. ITC, but the writ has been denied by the Court.

The patent context is also more complicated than the copyright context, making a "peer-to-peer" comparison (and possible extrapolation) perilous. The fundamental difference between a copyright and a patent right is that the first right originates automatically through the mere creation of the work, giving birth to a (quasi) universal perimeter of protection (1886 Berne Convention) whereas the patent right is only obtained through a patent application followed by a patent grant, giving birth to a national perimeter of protection. Consequently, patent protection comes with a patent strategy, where a company will decide on a country-by-country basis, using a cost-benefit analysis, whether to apply for (and maintain) a patent in each respective country; copyright on the other hand does not need to be nationally registered and title stems from the mere creation of the work.

The importation of a product that is lawfully made and sold in a country where the U.S. patentee has decided not to file (or maintain) a patent, should therefore not automatically be subject to the exhaustion theory, because the patentee has decided not to incur the filing (and maintenance) cost and (likewise) not to reap the potential monopoly profits for the patented product in this country; whilst, in analogy with Adams vs. Burke, the application of the exhaustion theory can be defended on the basis that the patentee "receives the consideration for its use and […] parts with the right to restrict that use," it nevertheless remains a fact that the patentee has not received the monopoly consideration which he could have extracted when the sale would have been a patented sale. Consequently, the same economic concerns apply as those that were put forward in Kirtsaeng, i.e. (to quote the famous law of Murphy) "bad sales (of non-patented products) drive out good sales (of patented products)" opening a back door through which these products, sold under competitive conditions in a non-patented country, can undermine the price policy applied by the patentee in those countries where he has elected to file and maintain a patent.

This same discussion has been held in the EU as part of the pharmaceutical saga of Merck vs. Stephar (ECJ decision of 1981) and vs. Primecrown (ECJ decision of 1997), where Merck opposed the importation of pharmaceutical products that it had sold, respectively, in Italy and in Spain and Portugal (where no patent rights were granted for pharmaceutical products at that time) into the UK, because the sales in those non-patented countries did not allow Merck to obtain "a return to the inventor to compensate for the costs of research" when they were subsequently introduced into the UK. Although the arguments of Merck were dismissed twice by the European Court of Justice ("It is for the proprietor of the patent to decide, in the light of all the circumstances, under what conditions he will market his product, including the possibility of marketing it in a Member State where the law does not provide patent protection for the product in question. If he decides to do so he must then accept the consequences of his choice as regards the free movement of the product within the Common Market"), the opinion of the Advocate General Mr. Fennelly in the second Merck case demonstrates the same hesitation as the one displayed by dissenting judge Ginsburg in Kirtsaeng ("The effect of the rule would be that, in order to avoid damage to the value of its national patent rights in those Member States which protect them, the patentee is encouraged to partition the Common Market in a different way, i. e. through refusing to supply units of its products to the markets of those Member States where his rights arc not recognized: […] in other words, it would favour commercially irrational decisions to withhold products from the markets of such States, where sales of the product would hold out some prospect of profit").

Finally, a salient detail of this decision that has largely gone unnoticed, is that the textbooks purchased by Mr. Kirtsaeng in Thailand contained the following notice: "This book is authorized for sale in Europe, Asia, Africa and the Middle East only and may not be exported out of these territories. Exportation from or importation of this book to another region without the publisher's authorization is illegal and is a violation of the publisher's rights." This notice made the sale conditional, and since the decision in Mallinckrodt vs. Medipart (Fed. Cir. 1992), post-sale restrictions prevent the application of the exhaustion doctrine, unless those restrictions violate some other policy such as the antitrust rules. Could this clause have saved John Wiley against the exhaustion of his rights through a first sale? I do not have the impression that this argument has been brought up before the court (the issue is not broached at all by the Supreme Court), but nothing is as sure as the 2008 Quanta vs. LGE decision, which upheld the exhaustion of rights despite the use of restrictive notices on the product. The effects that restrictive covenants, whether through limited licenses or post-sale restrictions, may have on the application of the exhaustion theory remain therefore open-ended.

2. Bowman vs. Monsanto (U.S. Supreme Court May 13, 2013, 569 U.S. ___, 2013)

This decision has been addressed as well in the section "Recent U.S. Decisions" of les Nouvelles (September 2013), and I refer to the overview given therein for a more detailed background of this case.

The unique issue at stake in this case was the nature of the product: self-replicating seeds (soybeans). The seeds, when grown, result in plants containing themselves the very same seeds. Consequently, by selling only one seed, theoretically the purchaser acquires an unlimited number of seeds since the resulting crop can be used over and over again for successive planting and harvesting of the seeds.

In order to avoid this type of "nuclear chain" reaction, Monsanto sold the seeds under terms of agreement whereby the purchaser was allowed to plant the purchased seeds in one season; the resulting crop should then either be consumed or sold as a commodity to downstream processing companies.

When Mr. Bowman used the seeds for successive plantings and Monsanto became aware of this practice, he sued Mr. Bowman for infringement. The defense of exhaustion was unanimously dismissed by the Supreme Court: patent exhaustion does not permit a farmer to reproduce patented seeds through planting and harvesting without the patent holder's permission.

Although the decision by itself is not surprising, there is one trait that has remained unexplored and that could have provided for more interesting developments. In fact, according to the facts exposed in the ruling, Mr. Bowman proceeded in three steps: (1) he purchased the seeds each year from Monsanto for his first crop of the season; (2) he purchased "commodity soybeans" from a grain elevator and planted these for the second "late season" crop; (3) of the plants growing out of this second planting, he saved the seeds for his second (third, fourth, etc.) year's "late season" planting.

There is no doubt that step 1 is authorized (legitimate licensed use) and step 3 is unauthorized (reproduction of patented article). But under the second step, Mr. Bowman was using the seeds in accordance with its very nature, i.e. for planting; the only (fundamental) difference being that under the first step, he purchased the seeds from Monsanto under the terms of a restrictive license agreement; whereas under the second step, he purchased the seeds from a grain elevator under the terms of a sales agreement which (as far as I am aware, the details were not provided in the decision) did not restrict the purchaser in the use of the product. There was no replication under this second step as there was in the third step; under the second step (like under the first step), Mr. Bowman purchased a seed in order to plant the same and grow consumables, while under the third step, Mr. Bowman replicated the seeds in order to grow seeds (and maybe consumables). The second step is different from the first step only with regard to the source of the supply (manufacturer under the first step, wholesaler under the second step) and the nature of the product (sale as a seed under the first step, sale as a commodity under the second step).

The question is therefore: where the seed is conditionally sold under the first transaction (from Monsanto to farmer A) with the "single use" restriction that the seeds were only to be planted in one season, and the soybeans grown from that first planting are subsequently unconditionally sold from farmer A to the grain elevator and, subsequently, from the grain elevator to Mr. Bowman (it does not appear from the Monsanto license agreement that the purchaser had to impose the same limited license conditions to future purchasers, and even if that were the case, it does not appear that the grain elevator did indeed impose these same restrictions on Mr. Bowman), would Monsanto still have been able to oppose his patent right accordingly against Mr. Bowman? This issue remains outstanding since the latent bifurcation in Quanta vs. LGE on the one hand and Mallickrodt vs. Medipart on the other hand on the effect of sales restrictions on the exhaustion (or not) of the underlying patent right. The Supreme Court simply deducts that under the second step, Mr. Bowman produced additional patented soybeans without Monsanto's permission. This is true, but the dual nature of the product (commodity and seed at the same time) plus the purchase thereof on the marketplace without any restrictive covenant, whether as a notification on the package or through the general conditions of sale, leaves open the question if the patent right should nevertheless not be considered as exhausted—albeit subject to the particular circumstances of this case where Mr. Bowman was very much aware of the user limitations with respect to soybean seeds he purchased as a result of his previous transactions with Monsanto (cf. General Talking Pictures vs. Western Electric [Supreme Court 1938] where exhaustion was precluded because the purchaser was deemed to have known of and actively induced breach of the field of use license restrictions).

If we make the parallel with EU law, it is not certain that the ECJ would have come up with the same result— although it is difficult to anticipate the Court's decision having regard to the specific self-replicating nature of this product. The ruling of the Court in the Peak Holding vs. Axolin decision (2004) leaves no doubt as to the effect that restrictive contract clauses may have on the patent right: "Exhaustion occurs solely by virtue of the putting on the market in the EEA by the proprietor. Any stipulation, in the act of sale effecting the first putting on the market in the EEA, of territorial restrictions on the right to resell the goods concerns only the relations between the parties to that act. It cannot preclude the exhaustion provided for by the Directive."

The question is also whether the economic rationale put forward by the Supreme Court is convincing. At stake is the factual finding that "the grower could multiply his initial purchase, and then multiply that new creation, ad infinitum—each time profiting from the patented seed without compensating its inventor." But this very much depends on the business model applied by the vendor—like a standard royalty deal, where the patentee can either license under a "per unit" formula (running royalty) or a "all-in" formula (lumps sum payment), so the seed manufacturer can sell the seed under a "single use" formula or a fully capitalized price, discounting for the loss of future revenue as a result of the self-replicating nature of the product. The downstream purchaser of soybeans does not know what business model the seed manufacturer has applied at the instance of the first sale—even more so when the downstream sale has been made without accessory use limitations. The argument of Mr. Bowman that "seeds are meant to be planted" is not without merit in this perspective—always subject to the personal knowledge that he had of the sales conditions applied by Monsanto.

Moreover, it may be scientifically questioned whether after a first purchase, the seed could be multiplied ad infinitum; the constant exposure of the seed to (in this case) aggressive herbicides (Round-up) may suppose that the resistant properties of these seeds, object of the patent, will diminish and vanish over time. Consequently, there will always remain a market for first-sale seeds, despite the self-replicating nature thereof.

The Monsanto-Bowman decision remains thus of a limited interest: not only because of the very nature of the infringing act (reproduction of self-replicating seeds), but also because of the case-specific ruling that the Supreme Court itself pronounced at the end of its ruling: "Our holding today is limited—addressing the situation before us, rather than every one involving a self-replicating product. We recognize that such inventions are becoming ever more prevalent, complex, and diverse. In another case, the article's self-replication might occur outside the purchaser's control. Or it might be a necessary but incidental step in using the item for another purpose."

So in this area as well, the exhaustion theory is not yet exhausted!

3. Capitol Records vs. ReDigi (U.S. District Court NY, March 30, 2013, 12 Civ. 95)

This software exhaustion case is very similar to the EU case of Oracle vs. UsedSoft and provides another example of where the U.S. and EU vision on exhaustion of rights differ.

In this case, ReDigi positioned itself as an online marketplace for the purchase and sale of "second-hand" digital music files. Upon purchase, the buyer downloads the music file which is concurrently deleted from the seller's computer.

Since the transfer protocol for the digital transmission of the music file requires an initial uploading of the latter on the servers of ReDigi, and a subsequent download on the computer of the purchaser, the District Court found that there was no resale of an original product, but a reproduction of the copyrighted code embedded in new material object (respectively, the ReDigi servers and the buyers hard drive).

Applying a linguistically correct, but technologically obsolete, interpretation of Section 106 of the Copyright Act, the court holds that "the first sale defense is limited to material items, like records, that the copyright owner put into the stream of commerce, and then relies on the "law of physics" in order to establish that "it is simply impossible that the same 'material object' can be transferred over the Internet." Consequently, as an unlawful reproduction, a digital music file sold on ReDigi is not "lawfully made under this title" as set forward in Section 109(a). Whilst the purposive construction of the Copyright Act sought by ReDigi in the new era of technological change has not rendered the provisions of Section 109 any less ambiguous, the Court simply points out that what ReDigi is trying to establish is an amendment of the Copyright Act, which is "a legislative prerogative that courts are unauthorized and ill suited to attempt."

Like in Wiley vs. Kirtsaeng, an interesting economic comparison creeps around the corner. Without explicitly saying so, the District Court seems to imply that the public policy rationale underlying the exhaustion doctrine finds its source in the devalued properties of traded goods, which means that the level-playing field of the IP right-holder in relation with sales of his patented (or copyrighted) products remains ringfenced against too important erosive effects exercised by the exhaustion theory, because (quoting the U.S. Copyright Office report on the digital millennium) "physical copies of works degrade with time and use, making used copies less desirable than new ones. Digital information does not degrade, […] the used copy is just as desirable (in fact, is indistinguishable from) a new copy of the same work. […] The ability of such used copies to compete for market share with new copies is thus far greater in the digital world." While this observation is certainly correct, this does not change in any way the century-old principle behind the exhaustion theory that when the IP right-holder has sold the good subject of the IP right, "he receives the consideration for its use and he parts with the right to restrict that use" (Adams vs. Burke); see also Princo Corp. v. ITC (Fed.Cir.2010) holding that the unconditional sale of a patented device exhausts the patentee's right to control the purchaser's use of that item thereafter because the patentee has bargained for and received full value for the goods.

The legal rationale for this decision, while convincing on face value, remains fragile. Although digital works are not in the strict sense of the words "sold," but distributed on the basis of a limited license, it cannot be denied (at least in relation with transfers implying physical tangible media like CD-ROMs or DVDs) that like any other copyrighted work, a change of title of the support material takes place (equivalent to a sale) whilst the editor retains property rights in the contents (equivalent to a license). The explanation given in the December 2013 contribution of Ilaria Maggioni (see above chapter 1) that "the fundamental difference between a physical and digital product is the nature of the legal transaction that is used to handle digital versus non-digital works," i.e. non-digital works are transferred through an actual sale and digital works under a limited license, is only one side of the medal because it reflects current practices. However, faced with the legal consequences, nothing prevents book publishers and record companies, eager to stop the "bleeding" caused by the first sale doctrine, to structure their book and record sales as limited licenses.

This same duality was recognized by the European Court of Justice in the 3le vs. UsedSoft case (2011) that I have reviewed in detail in les Nouvelles of March 2013. Parting from an entirely different perspective as the NY District Court, the ECJ held that "from an economic point of view, the sale of a computer program on CD-ROM or DVD and the sale of a program by downloading from the internet are similar. The on-line transmission method is the functional equivalent of the supply of a material medium." Consequently, in consideration of making available for downloading a copy of the computer program with the intention of making the copy usable by the customer on a permanent basis, "in return for payment of a fee designed to enable the copyright holder to obtain a remuneration corresponding to the economic value of the copy of the work of which it is the proprietor," the essential function of the copyright has been fulfilled. As Advocate General Bot puts it in his conclusions for this case, "Allowing him to control the resale of that copy […] would have the effect not of protecting the specific subject-matter of the copyright but of extending the monopoly on the exploitation of that right."

In a statement, ReDigi said it was "disappointed" by the ruling and would appeal it, but so far no action seems to have been undertaken.

4. Keurig vs. Sturm Foods (Fed. Cir. Court of Appeals October 17, 2013, no. 2013–1072)

Keurig manufactures and sells coffee brewers and cartridges for use in those brewers. This is probably the invention that most of us use every day: insert the cartridge into the brewer, the hot water will run through the cartridge, and your cup of coffee is ready. Keurig owned patents directed both to brewers and to methods of using them to make beverages—the present case concerns the method claim.

Sturm manufactures and sells cartridges for use in Keurig's brewers, and was sued by Keurig for inducing infringement of its method patent.

Contrary to the two milestone decisions of the Supreme Court in method claim exhaustion, United States v. Univis Lens (1942) and Quanta vs. LGE (2008) that dealt with unpatented products sold to a third party who subsequently used these products as part of the (patented) method, the product sold in this case was a patented product (brewer) whose claims extended to "a method of brewing a beverage from a beverage medium contained in a disposable cartridge."

This little detail did not dissuade the Court in restating the application of Quanta: "Keurig sold its patented brewers without conditions and its purchasers therefore obtained the unfettered right to use them in any way they chose, at least as against a challenge from Keurig," adding that "Here, Keurig is attempting to impermissibly restrict purchasers of Keurig brewers from using non-Keurig cartridges by invoking patent law to enforce restrictions on the post-sale use of its patented product." Its conclusion is, therefore, that "The claims of both the '488 patent and the '938 patent are directed to the brewers and the use of the brewers; therefore, Keurig cannot preclude an individual who purchased one of its brewers from using a non-Keurig cartridge with that brewer."

Interestingly, a similar case was judged nearly simultaneously in the UK (Nestec vs. Dualit), where Nestec accused Dualit of supplying an essential element of the patented system, thereby practicing an act of contributory infringement. The High Court considered that the consumer did not "make" the system as claimed in the patent when he used one of Dualit's capsules in a Nespresso machine: the capsule was an entirely subsidiary part of the system. "By consenting to the manufacture and sale of Nespresso machines, Nestec have exhausted their rights under the patent to restrict purchaser's freedom to use such machines in accordance with their normal function."

The devil is in the detail and both the U.S. and the UK decision contain an important qualification to the ruling: the machines were sold in both cases "without conditions." Which means that we get back to square one: if such restrictive conditions would have been introduced, could the supplier of brewer machines have opposed its patent rights against subsequent independent suppliers of coffee cartridges? Both decisions seem to imply this consequence, which makes the need for a definitive ruling on this matter even more pressing. Quanta did not make the "quantum leap" that many hoped for which makes that the current state of the law can still be interpreted as authorizing the supplier, by introducing restrictive conditions in his agreement, to "have your pudding and NOT eat it too."

The German District Court has also accepted the exhaustion of the patent right of Nespresso with the sale of the Nespresso machines, since the use of these machines by the consumers with capsules of third parties forms part of the intended use of those machines.

The coffee war is still lingering and more will probably be said on this subject in Part 4 of this Exhaustion series.

5. Lifescan Scotland vs. Shasta Technologies (Fed. Cir. Court of Appeals November 4, 2013, 2013-1271)

And not only is the coffee war still lingering, the method exhaustion battle itself is also still ravaging, as demonstrated by the Lifescan vs. Shasta Technologies decision, that involved two determinative "method exhaustion" questions: (1) when can a product be said to "embody the essential features of a patented method," and (2) is exhaustion triggered when the patentee provides the product incorporating such essential features for free?

In this case, the patented method consisted in a combination of an electrochemical meter and disposable test strips equipped with two separate working electrodes (instead of one compared to the prior art) in order to measure blood glucose levels; the invention claimed an improved reading because the system permitted to detect inadequate sample volumes or operational defects if the readers of the two electrodes differed significantly.

The first interesting aspect of this case lies in the entirely different interpretations related to the application of the method claim exhaustion by the majority opinion formulated by judge Dyk on the one hand and the dissenting opinion written by judge Reyna on the other hand: where the majority opinion retained that "the undisputed facts, the specification of the patent, and the prosecution history all suggest that the claimed inventive concept of the method claims of the '105 patent lies in the meter, rather than the strips, because the meters 'control' and 'carry out' the inventive functions of the method claims," the dissenting opinion considers that "but for the specialized test strips required by LifeScan's patented method, the blood glucose meter alone could not perform the 'comparing' and 'giving an indication of an error' steps viewed by the majority as essential to the patented method."

The discord between the respective opinions calls into question whether the "essential features" test is really the appropriate test for distinction, since in a combination claim A+B where one of the elements is not entirely standard as was the case in Quanta, each element is essential to the working of the other. Would the ruling have been different if instead of Shatsa supplying disposable test strips, it had supplied the meter equipment (if supposedly the apparatus had been unpatented which was not the case in LifeScan) holding that the method claim was exhausted by the sales of test strips by LifeScan to a customer? If we draw the parallel with the coffee case, by simply buying the (patented) capsule from a Nespresso store, the purchaser would he be exempt from patent infringement (and the supplier from contributory infringement) if he had acquired the (non-patented) equipment from Keurig / Dualit since the capsule was an essential element designed to fit this type of equipment ? Method claims by definition imply an interlocking of different elements that, working together, represent the inventive feature of the product; focusing on one of these elements rather than the other as being "essential" may therefore appear artificial, since the one is incomplete without the other.

A more distinctive test may be to rely on the second holding of the Quanta court, i.e. do the products have a reasonable alternative noninfringing use? If a product A marketed by the patentee has no reasonable noninfringing (and, I'd like to add, "substantial") use besides the practice of the patented method claim, then it must be held that the method patent on the combination A+B is exhausted when a customer purchases A and uses this product, in accordance with its intended purpose, in combination with B, even if product B also can be said to substantially embody the patent. This perspective may have been part of the ruling in Keurig when the court held that a potential noninfringing use prevents exhaustion when the use in question is the very use contemplated by the patented invention itself. Another possible criteria of distinction can be found in the UK High Court's reference to the capsule being altogether of a subsidiary nature having regard to the entire patented claim; like the micro-components were under Quanta and the lens blanks under Univis.

In order to demonstrate the working of this test, I'd like to refer to the example that I used in my September 2009 article for les Nouvelles, "Drafting of Royalty Clauses: 30 Ways to Head for Windfall or Pitfall," i.e. a patentee that has developed an acid formula that is capable of eliminating asphaltene formations in oil wells. Besides the product patent, the patentee also develops a method patent where the injection of this compound in addition with certain (as in Quanta) standard products under certain operating conditions (pressure, temperature, viscosity, …) delivers an optimum result. Under this example, the working of the method claim requires two essential patented steps: the patented chemical formula and the patented injection method. Both "substantially embody the patented invention" making the application of this part of the Quanta decision of relative value. But the "reasonable alternative use" test allows to determine whether the purchaser of the chemical product can claim that the sale thereof has exhausted the method patent: if the only "reasonable and intended" use of such products is to inject the latter as described in the method claim, then the method claim should be considered exhausted. Under this example, this would unlikely be the case: the method describes a means to optimize the asphaltene formation inhibition, but this method is not the only reasonable and intended means available to the oilwell operator: the method described a "preferred means" without culminating in an "exclusive means" (as in Quanta). Whether or not the chemical compound was patented or not would probably not influence the appreciation.

The second important attribute of this decision to the edifice of the exhaustion doctrine lies in its majority ruling that the said doctrine is triggered by "all authorized transfers of title, regardless of whether the particular transfer at issue constituted a gift or a sale." According to the facts, Lifescan sells 40 percent of its meters at below cost prices, while 60 percent is distributed for free through health care providers, in the expectation that users will purchase the Lifescan test strips from which it derives a profit. Holding that "none of the cases cited by Lifescan involved any suggestion that exhaustion could be avoided by showing the absence or inadequacy of the patentee's reward in a transfer by gift," the Court deducts that "where a patentee unconditionally parts with ownership of an article, it cannot later complain that the approach that it chose results in an inadequate reward and that therefore ordinary principles of patent exhaustion should not apply." Likewise, judge Reyna dissents: "a patent system premised on granting the patentee a 'hope of receiving a future benefit' is one where there is no secure benefit to be had and that does not promote the progress of the useful arts."

Inadequacy of reward is certainly not a valid motive to prevent exhaustion to happen (cf. the Tessera decision reviewed under point 6). This has been clearly recognized in the EU under the two Merck decisions where the European Court explained that the patent allows the patentee "a monopoly in exploiting his product, to obtain the reward for his creative effort without, however, guaranteeing that he will obtain such a reward in all circumstances"; it is up to the proprietor of the patent "to decide, in the light of all the circumstances, under what conditions he will market his product," after which "he must then accept the consequences of his choice."

It seems to me that the question is more one of commercial strategy pursued by the patentee: the latter could have protected his business model by choosing the appropriate contractual framework, rather than relying of the strength of his patent claim. First, the Court of Appeals concludes itself that the absence of consideration is no barrier to the application of patent exhaustion principles "in the case of an authorized and unconditional transfer of title"—in other words, LifeScan could have conditioned the gift of the meter equipment to exclusive purchases of Lifescan test strips, provided the exclusivity terms respect antitrust legislation. Second, instead of a sale, Lifescan could have provided the equipment under a rental or lease arrangement, with the appropriate restrictive covenants of use. Third, if technically possible, LifeScan could have provided for the incorporation of a chip on its strips readable only through an adapted scanning device within the metering equipment. Even if the contractual clauses would not have prevented Shasta from commercializing its strips, LifeScan could have acted under breach of contract against its customers— including through a rescission of the sale or rental.

6. Tessera vs. ITC (Fed. Cir. Court of Appeals May 23, 2011, n° 10-1176)

Although an older case, it is worth recalling to memory this case in relation with the preceding sections, since it focuses on the essential question of authorized vs. unauthorized sales. Tessera, confronted with sales of its products under one of its patent licenses without receiving payment of royalties in relation with these sales, initiated an ITC action against an importer of these products. The latter invoked the first sale defense since it had legitimately acquired the product from a licensee of Tessera, but Tessera opposed that since it had never received the corresponding royalty payments from this licensee, it cannot be considered to have authorized such sale; whereas the patent exhaustion theory has been developed in order to avoid "double dipping," Tessera argued that it had not even received a "single recovery."

The arguments of Tessera get short shrift from the Court: "That some licensees subsequently renege or fall behind on their royalty payments does not convert a once authorized sale into a non-authorized sale." The Court continues "that absurd result would cast a cloud of uncertainty over every sale, and every product in the possession of a customer of the licensee, and would be wholly inconsistent with the fundamental purpose of patent exhaustion—to prohibit postsale restrictions on the use of a patented article."

Apart from the clarification of the Court that the simple breach of contract by the licensee towards its licensor does not thereby convert the sales made by that licensee to third parties into potential patent infringement situations for those customers, it also seems that the Federal Circuit hereby accessorily pronounces the demise of the "scepter of Mallinckrodt" by holding out, as a kind of "obiter dictum," that the fundamental purpose of patent exhaustion is to prohibit post-sale restrictions—of which the "single use" restriction that was legitimized in the Mallinckrodt case is the perfect example!

Whether or not the Federal Circuit has hereby explicitly drawn the consequences that remained only implicit in Quanta, is…to be continued!