After Quanta, Lower Courts Expand the Patent Exhaustion Doctrine

By Thomas Carey. and Yakov Sidorin

April 2009 IP Update

The patent exhaustion (or “first sale”) doctrine generally prohibits a patentee from imposing restrictions or collecting royalties on the resale of a patented article once it has been sold. The Supreme Court reinforced this doctrine in Quanta Computer, Inc. v. LG Electronics, Inc. (2008) by applying it to components involved in a patented process and, in some cases, to the resale of such components even if they must be combined with other components in order to practice the patented method.

According to the Court, if the only reasonable and intended use for an item is to practice the inventive features of a patent, then the patent holder exhausts his patent rights with respect to that item as soon as he sells it.

Recently, two federal district courts have relied on Quanta to expand the reach of the exhaustion doctrine to areas that the Supreme Court did not even address in that case. One decision focused on the effect of foreign sales patent exhaustion. The other addressed the patentee’s right to prohibit reconstruction of the item by a third party.

As it happens, each decision conflicts with pre-Quanta opinions of the Federal Circuit, whose pronouncements ordinarily are binding precedent throughout the U.S. on patent matters.

Foreign Sales.  In LG Electronics, Inc. v. Hitachi, Ltd., a federal judge in the Northern District of California considered whether patent exhaustion is triggered by a foreign sale. In doing so, the court relied on a Ninth Circuit case that allows a lower court not to follow a circuit court precedent where a subsequent Supreme Court decision has “undercut the theory of reasoning underlying the prior circuit precedent in such a way that the cases are clearly irreconcilable.”

In Fuji Photo Film Co., Ltd. v. Jazz Photo Corp., a 2005 decision, the Federal Circuit had held that sales outside of the United States do not trigger the patent exhaustion doctrine. Last year, the Supreme Court in Quanta did not overrule this decision or even consider the question of foreign sales.

However, in addressing a different question – whether method claims are subject to the patent exhaustion doctrine – the Supreme Court reasoned that if the doctrine did not apply to method claims, the result would be an “end-run around exhaustion.” The Supreme Court worried that “patentees seeking to avoid patent exhaustion could simply draft their patent claims to describe a method rather than an apparatus” and “any downstream purchasers of the patented systems [would] be liable for patent infringement.”

The Hitachi court observed that drawing a distinction between domestic and foreign sales would negate the Supreme Court’s intent in Quanta to eliminate the possibility for a patentee to first reap the benefit of its patent by authorizing the sale of the item and then sue a downstream purchaser for patent infringement. Concluding that such a situation would effectively permit the “end-run around exhaustion” disapproved in Quanta, the court declined to follow the Federal Circuit precedent and held that foreign sales do trigger the patent exhaustion doctrine.

Contractual Restrictions.  At issue in Static Control Components, Inc. v. Lexmark International, Inc.  was the ability of the patentee to enforce a “prebate” program in which Lexmark was selling patented printer cartridges at a discount in exchange for the buyer’s agreement to use the cartridges only once and then return the empty cartridges to Lexmark. Static Control was selling parts and supplies to third parties for refilling the used cartridges, thus facilitating their resale to end users.

Prior to Quanta, the district  court in Eastern Kentucky had considered Lexmark’s single-use restriction on the printer cartridges to be lawful. The court held that the patent exhaustion doctrine did not apply.  Relying on the Federal Circuit’s opinion inMallinckrodt, Inc. v. Medipart, Inc. (1992), the district court held that the restrictive sale terms were enforceable because Lexmark had not received full consideration for the value of its patent, and was entitled to enforce its restrictive terms in exchange for the discount that it had offered.

The district court reconsidered its decision in light of Quanta. It concluded thatQuanta  had implicitly overruled Mallinckrodt, at least insofar as it approved resale or reuse restrictions upon users of the patented articles, rather than merchants licensed to make or sell them. On that basis, the district court held that Lexmark’s terms of sale, requiring return of the used cartridge, were unenforceable.

These two district court decisions show that Quanta is being interpreted broadly to defeat rights of patentees who seek to limit the re-use or resale of their patented articles, notwithstanding Federal Circuit decisions that favor the patentee.

It is not clear whether the Federal Circuit will reconsider its own precedents, or simply overrule the district courts that are interpreting Quanta to govern aspects of patent law not considered by the Supreme Court in that opinion.  In the meanwhile, patentees cannot assume that resale restrictions on patented goods, however carefully they may be crafted, will be enforceable.