The Supreme Court's recent unanimous decision in Quanta Computer, Inc., et. al. v. LG Electronics, Inc., 553 U.S. ___, 2008 U.S. LEXIS 4702 (June 9, 2008), expands the scope of the patent exhaustion doctrine and redefines an area of patent law that had been subject to considerable confusion for decades. Holding that method claims and so-called 'combination' claims (covering a component with other items) can be exhausted by the sale of a component, the Supreme Court reversed decades-old Federal Circuit precedent. At the same time, however, the Court left open the extent to which application of the exhaustion doctrine may be contractually limited.
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Quanta: Supreme Court Expands the Scope of Exhaustion; Redefines Licensing Principles
The Landscape Before Quanta
Patent exhaustion (also known as the 'first-sale doctrine') is a judicially created doctrine that holds that the first authorized sale of a patented product by a patentee or its licensee places that product outside the patent owner's rights of exclusion. See United States v. Univis Lens Co., 316 U.S. 241, 249 (1942) (acknowledging 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'). The theory behind this doctrine is that once the patentee has received consideration for releasing the product from the patent's sphere of exclusion through an authorized sale, the patentee can no longer restrict its use.
In considering application of exhaustion, parties most often wrestle with whether a licensee's authorized sale of a component exhausts not only patent claims covering the component, but also claims covering a system or combination incorporating that component (including finished systems), or covering methods of using the component. As modern licensing practices have evolved, patent licensors ' particularly in high-tech industries ' often seek contractually to limit application of exhaustion so that they may obtain additional royalties from those downstream of their licensees, such as original equipment manufacturers and those who acquire licensee-manufactured components and combine them into patented systems or combinations. The Quanta case followed this typical fact pattern, as the patentee attempted to prevent its licensee's customers from having rights to practice computer system and method claims based on their purchase of components (e.g., microprocessors) from the licensee.
Federal Circuit precedent prior to Quanta disallowed application of exhaustion to method claims, Glass Equip. Dev., Inc. v. Besten, Inc., 174 F.3d 1337 (Fed. Cir. 1999), thus limiting possible downstream immunities under method claims to only the doctrine of implied license, which could be contractually waived by the licensee. See Bandag, Inc. v. Al Bolser's Tire Stores, Inc., 750 F.2d 903 (Fed. Cir. 1984). On the other hand, the Federal Circuit upheld application of exhaustion to combination claims even before Quanta, Cyrix Corp. v. Intel Corp, 846 F. Supp. 522 (E.D. Tex. 1994), aff'd without op., 42 F.3d 1411 (Fed. Cir. 1994), but also recognized the patentee's right to impose contractual restrictions. B. Braun Med. v. Abbott Labs., 124 F.3d 1419 (Fed. Cir. 1997) (holding that the 'exhaustion doctrine ' does not apply to an expressly conditional sale or license').
Quanta has changed the landscape. Method claims are now subject to the same exhaustion rules as combination or system claims. In addition, contractual conditions on exhaustion, while not definitively rejected by the Court, may no longer be enforceable. In the wake of Quanta, patent licensors and licensees alike would be well-advised to review their existing patent licenses to determine the extent to which exhaustion may impact the scope and coverage of the licenses and any royalty-obligations thereunder. Likewise, parties contemplating, or in, litigation should review or possibly reconsider relevant licensing and supply agreements and the products licensed or sold thereunder to assess the impact of Quanta on liability and the damages recoverable in litigation.
Case Background
In Quanta, LGE licensed Intel to, inter alia, make and sell microprocessors and chipsets practicing LGE's patents. Quanta at **10-11. The License Agreement expressly purported not to alter the usual rules of patent exhaustion, but attempted to restrict the implied rights that Intel could pass along to third parties, stating that no license was 'granted by either party ' to any third party for the combination by a third party of Licensed Products of either party with items, components, or the like acquired ' from sources other than a party hereto, or for the use, import, offer or sale of such combination.' Id. Intel was required by a separate Master Agreement to notify its customers of the License Agreement limitation by informing them that Intel's products did not convey a license from LGE 'expressly or by implication, to any product that [they] make by combining an Intel product with any non-Intel product.' Id. at **11-12.
The Federal Circuit agreed with the district court that method claims could not be exhausted. See LG Electronics, Inc. v. Bizcom Electronics, Inc., 453 F.3d 1364 (Fed. Cir. 2006). The Federal Circuit reversed the district court's application of
exhaustion to the system claims, however, holding that '[a]lthough Intel was free to sell its microprocessors and chipsets, those sales were conditional, and Intel's customers were expressly prohibited from infringing LGE's combination patents.' LG Electronics, Inc., 453 F.3d at 1370.
In a closely followed decision, which attracted more than 25 amicus briefs, the Supreme Court reversed the Federal Circuit and found that all of LGE's asserted method and apparatus claims were exhausted by Intel's authorized sales of its microprocessors and chipsets. The Supreme Court held unequivocally that '[because the exhaustion doctrine applies to method patents, and because the [LGE-Intel] license authorizes the sale of components that substantially embody the patents in suit, the sale exhausted the patents.' Quanta at *7.
Key Holdings
Notable aspects of the Supreme Court's decision are as follows:
- Post-Sale Restrictions on the Right to Use Are Prohibited Under Patent Law: The Court reiterated the 'longstanding principle that, when a patented item is 'once lawfully made and sold, there is no restriction on [its] use to be implied for the benefit of the patentee.' Id. at *22. Although the Court did not definitively reject contractual restrictions on exhaustion, the Court's analysis arguably calls such restrictions into question.
- Method Claims Are Exhausted By Articles Embodying the Claimed Method: Overturning long-standing Federal Circuit precedent that method claims cannot be exhausted, the Supreme Court explained that to hold otherwise would invite patentees to simply draft claims in method form to avoid exhaustion and emphasized the 'danger of allowing such an end-run around exhaustion.' Id. at *22. This holding is likely to have a substantial impact on computer software claims in particular.
- System-Level Claims Are Exhausted By Components 'Substantially Embodying the Patents in Suit': The Supreme Court agreed that Univis Lens ' the most recent Supreme Court decision on patent exhaustion prior to Quanta ' governed the case at bar. In Univis Lens, the sale of unfinished lens blanks exhausted claims to the completed products because the only reasonable and intended use of the unfinished components was to practice the patent and because they 'embodie[d] essential features of [the] patented invention.' Univis Lens Co., 316 U.S. at 250. Following this precedent, the Court articulated a two-part test for whether a component 'substantially embodies' a patent: 1) the reasonable and intended use of the component must be to practice the patent and 2) the component must embody 'essential features' of the patented invention. Quanta at **35-36.
The Supreme Court also provided some limited guidance for application of this test:
- 'Reasonable and Intended Use': Rather than provide an affirmative definition of such a use, the Court's analysis focused on what does not qualify as a 'reasonable and intended use' ' specifically, uses that do not utilize all of the features of the product as sold do not qualify. The Court also determined that the availability of legally noninfringing uses ' such as use as replacement parts in existing licensed systems or use outside the United States could not defeat exhaustion because the question is 'whether the product is 'capable of use only in practicing the patent,' not whether those uses are infringing.' Id. at *26 (emph. in original).
- 'Essential Features': The Court also did not provide an express definition for this prong, but held that it was met in this case because 'the only step necessary to practice the patent is application of common processes or the addition of standard parts' and '[e]verything inventive about each patent is embodied in the Intel Products.' Id. at *28. This issue is likely to be heavily litigated, as litigants and courts struggle to define the 'essential features' of a claimed invention. Indeed, this issue could add a layer of complexity to construing patent claims in litigation.
Conclusion
The Supreme Court's Quanta decision is as notable for the issues that remain open as it is for the issues that it decides. With regard to whether the doctrine of patent exhaustion may be restricted, such as through a conditional sale, the Supreme Court did not have occasion to pass on the scope of permissible contractual restrictions and conditions, as LGE's license to Intel expressly purported not to restrict application of exhaustion. This case thus leaves open the question of what types of restrictions and conditions on a licensee's authority to sell may be deemed acceptable and how those restrictions may be structured.
The Court also hinted in a footnote that even though patent exhaustion precluded patent remedies to LGE, the holding did 'not necessarily limit LGE's other contract rights.' But because LGE's complaint did not include a breach-of-contract claim, the Court expressed 'no opinion' as to 'whether contract damages might be available even though exhaustion operates to eliminate patent damages.' Id. In so doing, the Court implied that patentees may still be able to seek contractual remedies for breach of conditions on license grants that preclude licensees from
combining components with other items. Id. at *35.
In summary, the Quanta case addressed some long-standing issues underlying exhaustion, but also left other issues open, which will likely lead to continued debates for some time to come. This decision bears careful review by parties considering new patent license agreements as well as by parties to existing patent license agreements or those litigating patent claims that could be impacted by existing license agreements.
Amber Rovner is Counsel in the Austin office of Weil, Gotshal & Manges LLP., and is a member of the firm's Patent Litigation and Patent Appellate Practice groups. Charan Sandhu is a partner in Weil's New York office, and is a member of the firm's Technology and IP Transactions group. Larry Thompson is an associate in Weil's New York office, and is a member of the firm's Technology and IP Transactions group.
The Supreme Court's recent unanimous decision in Quanta Computer, Inc., et. al. v.
The Landscape Before Quanta
Patent exhaustion (also known as the 'first-sale doctrine') is a judicially created doctrine that holds that the first authorized sale of a patented product by a patentee or its licensee places that product outside the patent owner's rights of exclusion. See
In considering application of exhaustion, parties most often wrestle with whether a licensee's authorized sale of a component exhausts not only patent claims covering the component, but also claims covering a system or combination incorporating that component (including finished systems), or covering methods of using the component. As modern licensing practices have evolved, patent licensors ' particularly in high-tech industries ' often seek contractually to limit application of exhaustion so that they may obtain additional royalties from those downstream of their licensees, such as original equipment manufacturers and those who acquire licensee-manufactured components and combine them into patented systems or combinations. The Quanta case followed this typical fact pattern, as the patentee attempted to prevent its licensee's customers from having rights to practice computer system and method claims based on their purchase of components (e.g., microprocessors) from the licensee.
Federal Circuit precedent prior to Quanta disallowed application of exhaustion to method claims,
Quanta has changed the landscape. Method claims are now subject to the same exhaustion rules as combination or system claims. In addition, contractual conditions on exhaustion, while not definitively rejected by the Court, may no longer be enforceable. In the wake of Quanta, patent licensors and licensees alike would be well-advised to review their existing patent licenses to determine the extent to which exhaustion may impact the scope and coverage of the licenses and any royalty-obligations thereunder. Likewise, parties contemplating, or in, litigation should review or possibly reconsider relevant licensing and supply agreements and the products licensed or sold thereunder to assess the impact of Quanta on liability and the damages recoverable in litigation.
Case Background
In Quanta, LGE licensed Intel to, inter alia, make and sell microprocessors and chipsets practicing LGE's patents. Quanta at **10-11. The License Agreement expressly purported not to alter the usual rules of patent exhaustion, but attempted to restrict the implied rights that Intel could pass along to third parties, stating that no license was 'granted by either party ' to any third party for the combination by a third party of Licensed Products of either party with items, components, or the like acquired ' from sources other than a party hereto, or for the use, import, offer or sale of such combination.' Id. Intel was required by a separate Master Agreement to notify its customers of the License Agreement limitation by informing them that Intel's products did not convey a license from LGE 'expressly or by implication, to any product that [they] make by combining an Intel product with any non-Intel product.' Id. at **11-12.
The Federal Circuit agreed with the district court that method claims could not be exhausted. See
exhaustion to the system claims, however, holding that '[a]lthough Intel was free to sell its microprocessors and chipsets, those sales were conditional, and Intel's customers were expressly prohibited from infringing LGE's combination patents.'
In a closely followed decision, which attracted more than 25 amicus briefs, the Supreme Court reversed the Federal Circuit and found that all of LGE's asserted method and apparatus claims were exhausted by Intel's authorized sales of its microprocessors and chipsets. The Supreme Court held unequivocally that '[because the exhaustion doctrine applies to method patents, and because the [LGE-Intel] license authorizes the sale of components that substantially embody the patents in suit, the sale exhausted the patents.' Quanta at *7.
Key Holdings
Notable aspects of the Supreme Court's decision are as follows:
- Post-Sale Restrictions on the Right to Use Are Prohibited Under Patent Law: The Court reiterated the 'longstanding principle that, when a patented item is 'once lawfully made and sold, there is no restriction on [its] use to be implied for the benefit of the patentee.' Id. at *22. Although the Court did not definitively reject contractual restrictions on exhaustion, the Court's analysis arguably calls such restrictions into question.
- Method Claims Are Exhausted By Articles Embodying the Claimed Method: Overturning long-standing Federal Circuit precedent that method claims cannot be exhausted, the Supreme Court explained that to hold otherwise would invite patentees to simply draft claims in method form to avoid exhaustion and emphasized the 'danger of allowing such an end-run around exhaustion.' Id. at *22. This holding is likely to have a substantial impact on computer software claims in particular.
- System-Level Claims Are Exhausted By Components 'Substantially Embodying the Patents in Suit': The Supreme Court agreed that Univis Lens ' the most recent Supreme Court decision on patent exhaustion prior to Quanta ' governed the case at bar. In Univis Lens, the sale of unfinished lens blanks exhausted claims to the completed products because the only reasonable and intended use of the unfinished components was to practice the patent and because they 'embodie[d] essential features of [the] patented invention.' Univis Lens Co., 316 U.S. at 250. Following this precedent, the Court articulated a two-part test for whether a component 'substantially embodies' a patent: 1) the reasonable and intended use of the component must be to practice the patent and 2) the component must embody 'essential features' of the patented invention. Quanta at **35-36.
The Supreme Court also provided some limited guidance for application of this test:
- 'Reasonable and Intended Use': Rather than provide an affirmative definition of such a use, the Court's analysis focused on what does not qualify as a 'reasonable and intended use' ' specifically, uses that do not utilize all of the features of the product as sold do not qualify. The Court also determined that the availability of legally noninfringing uses ' such as use as replacement parts in existing licensed systems or use outside the United States could not defeat exhaustion because the question is 'whether the product is 'capable of use only in practicing the patent,' not whether those uses are infringing.' Id. at *26 (emph. in original).
- 'Essential Features': The Court also did not provide an express definition for this prong, but held that it was met in this case because 'the only step necessary to practice the patent is application of common processes or the addition of standard parts' and '[e]verything inventive about each patent is embodied in the Intel Products.' Id. at *28. This issue is likely to be heavily litigated, as litigants and courts struggle to define the 'essential features' of a claimed invention. Indeed, this issue could add a layer of complexity to construing patent claims in litigation.
Conclusion
The Supreme Court's Quanta decision is as notable for the issues that remain open as it is for the issues that it decides. With regard to whether the doctrine of patent exhaustion may be restricted, such as through a conditional sale, the Supreme Court did not have occasion to pass on the scope of permissible contractual restrictions and conditions, as LGE's license to Intel expressly purported not to restrict application of exhaustion. This case thus leaves open the question of what types of restrictions and conditions on a licensee's authority to sell may be deemed acceptable and how those restrictions may be structured.
The Court also hinted in a footnote that even though patent exhaustion precluded patent remedies to LGE, the holding did 'not necessarily limit LGE's other contract rights.' But because LGE's complaint did not include a breach-of-contract claim, the Court expressed 'no opinion' as to 'whether contract damages might be available even though exhaustion operates to eliminate patent damages.' Id. In so doing, the Court implied that patentees may still be able to seek contractual remedies for breach of conditions on license grants that preclude licensees from
combining components with other items. Id. at *35.
In summary, the Quanta case addressed some long-standing issues underlying exhaustion, but also left other issues open, which will likely lead to continued debates for some time to come. This decision bears careful review by parties considering new patent license agreements as well as by parties to existing patent license agreements or those litigating patent claims that could be impacted by existing license agreements.
Amber Rovner is Counsel in the Austin office of
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