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Quanta Computer V. LG Electronics: Reviving Exhaustion, Applying it to Method Patents

Background

LG Electronics ("LGE") owns the rights to several computer technology patents, all of which describe a computer operation or method, not actual products. LGE licensed these patents to Intel Corporation in a License Agreement that authorizes Intel to manufacture and sell microprocessors and chipsets that use and incorporate the LGE patents. LGE and Intel had a separate agreement ("Master Agreement") that required Intel to give its customers written notice that the license does not extend to a product made by combining an Intel Product with a non-Intel product. The Master Agreement states that breach of it does not affect the integrity and terms of the License Agreement.

Quanta purchased microprocessors and chipsets from Intel, and then manufactured computers using the Intel parts in combination with non-Intel parts, but without modifying the Intel parts. LGE sued Quanta, claiming this combination infringed the LGE patents. Quanta claimed that LGE's patents were exhausted when Intel sold Quanta the parts that embodied LGE's patent and therefore LGE has no further rights.

The District Court initially granted summary judgment in favor of Quanta, but upon reconsideration, denied the summary judgment on the grounds that the exhaustion doctrine does not apply to method patents. The Federal Circuit agreed that the patent exhaustion does not apply to method patents, and alternatively found that LGE did not license Intel to sell the Intel products to Quanta to combine with non-Intel products.

The United States Supreme Court heard the case on January 16, 2008 and issued its opinion, reversing the Federal Circuit and finding in favor of Quanta, on June 9, 2008.

The doctrine of patent exhaustion and its history pre-Quanta

The basic concept of patent exhaustion means that the first authorized sale of a patented item terminates all patent rights to that item. Quanta, 128 S.Ct. at 2115. The doctrine is premised on the notion that a patentee is entitled to a single royalty - in authorizing that first sale, the patentee presumably has bargained for and received the value of the patent right. The Supreme Court has explained that the touchstone of the patent exhaustion doctrine is "whether or not there has been such a disposition of the article that it may fairly be said that the patentee has received his reward for the use of the article." United States v. Masonite Corp., 316 U.S. 265, 278 (1942).

In the early 1900's, some courts allowed patentees to place post-sale restrictions on their patents that enabled them to exercise control (and receive additional royalties) in the downstream chain, long after the initial authorized sale. Quanta, 128 S.Ct. at 2115-2116.  But by 1917, the Supreme Court made it clear that such post-sale restrictions would not be tolerated. In Motion Picture Patents Co. v. Universal Film Mfg Co., 243 U.S. 502, 516 (1917), the court held that "the right to vend is exhausted by a single, unconditional sale, the article sold being thereby carried outside the monopoly of the patent law and rendered free of every restriction which the vendor may attempt to put upon it."

Prior to Quanta, the Supreme Court's most recent and important precedent on the exhaustion doctrine, including its application to components and method patents, was United States v. Univis Lens Co., 316 U.S. 241 (1942). In Univis, the patentee (Univis Corp.) held a patent with claims directed to an eyeglass lens and the method for making lenses by producing, grinding and polishing lens blanks. Univis Corp. licensed its related company, Univis Lens, to manufacture lens blanks.

Univis Lens sold the licensed blanks to wholesalers and retailers who would finish the grinding and polishing of the blanks through practice of Univis' patented method. The licenses to the wholesalers and retailers contained strict post-sale limitations as to whom the lens blanks could be sold and at what price.

The court held that upon Univis' licensed sale of the lens blanks, which had no realistic use except to practice the Univis patent, the patent rights regarding the lens blanks and finished lenses were exhausted. "[T]he 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, 316 U.S. at 249.

The Court stated:

"The first vending of any article manufactured under a patent puts the article beyond the reach of the monopoly which that patent confers. Whether the licensee sells the patented article in its complete form or sells it before completion for the purpose of enabling the buyer to finish and sell it, he has equally parted with the article, and made it the vehicle for transferring to the buyer ownership of the invention with respect to that article. To that extent he has parted with his patent monopoly in either case, and has received in the purchase price every benefit of that monopoly which the patent law secures to him. If he were permitted to control the price at which it could be sold by others he would extend his monopoly quite as much in the one case as in the other, and he would extend it beyond the fair meaning of the patent statutes and the construction which has hitherto been given to them." 316 U.S. at 252.

Despite the Univis holding, however, the Federal Circuit again allowed erosion of the exhaustion doctrine by allowing patentees to place post-sale restrictions and limitations on their patents. The seminal (and often criticized) ruling in Mallinckrodt, Inc.  v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992), enabled patentees to limit their customers to a significant extent in repairing, refurbishing, recycling and modifying equipment post-sale - a violation of the restriction constituted patent infringement unless the restriction violated another law such as antitrust law. The rationale for the holding: a patent owner bargains for and receives royalties based upon an anticipated and intended use; if the buyer makes other and additional uses out of the patent, the patent owner ought to be able to claim additional royalties for that non-bargained-for use.

The Mallinckrodt decision and its progeny have limited the law of patent exhaustion in various ways - a controversial result. Patent owners have relied upon these cases by drafting license agreements that the Federal Circuit has interpreted as preserving their rights to pursue infringement claims against downstream users who purchase and use the licensed product. Indeed, the Federal Circuit applied this same line of thinking when it affirmed the District Court's ruling against Quanta.(1)

Moreover, since Mallinckrodt, also in seeming contradiction to the Univis holding, the Federal Circuit has held that method claims are not subject to patent exhaustion.(2) The Federal Circuit has severely weakened the exhaustion doctrine by limiting it only to apparatus claims.

Quanta reaffirms Univis and revives the exhaustion doctrine

In its decision in Quanta, the Supreme Court relied heavily upon the precedent of Univis and conclusively held that the exhaustion doctrine does apply to method claims as well as apparatus claims.

The Court stated: "It is true that a patented method may not be sold in the same way as an article or device, but methods nonetheless may be 'embodied' in a product, the sale of which exhausts patent rights." 128 S.Ct. at 2117.

The Court warned that any other result "would seriously undermine the exhaustion doctrine. Patentees seeking to avoid patent exhaustion could simply draft their patent claims to describe a method rather than an apparatus." 128 S.Ct at 2117. This exhaustion-avoidance technique, if it were effective, would wreak havoc on downstream purchasers who could find themselves suddenly liable for patent infringement, unaware that a method encompassed in the product they purchased enjoys an inexhaustible patent.

After confirming that exhaustion applies to method claims, the court explained "the extent to which a product must embody a patent in order to trigger exhaustion." Id. at 2118. Again, the court looked to Univis for guidance, finding that when the licensed product that contains the patented method is really only capable of use when it practices the patented method, exhaustion applies:

"Like the Univis lens blanks, the Intel Products constitute a material part of the patented invention and all but completely practice the [LGE] patent. Here, as in Univis, the incomplete article substantially embodies the patent because the only step necessary to practice the patent is the application of common processes or the addition of standard parts. Everything inventive about each patent is embodied in the Intel Products." 128 S.Ct. at 2120.

LGE argued that exhaustion did not apply because Intel's sale to Quanta was not an "authorized" first sale. LGE asserted that the contractual post-sale restriction it imposed on its patents - namely, that LGE did not license Intel to sell the Intel Products to Quanta to combine with non-Intel products - prevented application of the doctrine. 128 S.Ct. at 2121. The Federal Circuit had agreed with this argument, following the precedent it had created for itself (that parties can contract around exhaustion) over the last 15 years.

But the Supreme Court disagreed. LGE had two separate agreements with Intel: a License Agreement that granted Intel the right to manufacture and sell LGE's patents, and a separate Master Agreement that contained the post-sale restriction. But the Master Agreement specifically stated that its breach did not affect the validity of the License Agreement. As a result, the License Agreement gave Intel the authority to sell its products containing the LGE patent, and that first authorized sale exhausts LGE's patents, regardless of the other agreement. Id. at 2121-2122.

Quanta leaves one imperfectly-answered question

There may be a lingering question about exhaustion when the component that embodies the patent has other non-infringing uses. For example, if the Intel products had thousands of non-infringing uses outside of the patented LGE process, but someone used the Intel product to practice the LGE patent, an argument could be made that exhaustion should not apply and LGE should have the right to pursue and infringement action against that user.

This certainly was not the case in Quanta, as the Intel chips have really no utility, even while embodying the LGE patent, until they are put into a computer and put to use practicing the patent. But what if the chips had numerous other uses, only one of which was to practice the LGE patent? Could exhaustion still apply? The overwhelming precedent indicates that exhaustion would not apply in such circumstances.

But the Quanta opinion includes this curious comment:

"While each Intel microprocessor and chipset practices thousands of individual patents, including some LGE patents not at issue in this case, the exhaustion analysis is not altered by the fact that more than one patent is practiced by the same product. The relevant consideration is whether the Intel Products that partially practice a patent - by, for example, embodying its essential features - exhaust that patent." 128 S.Ct. at 2121.

To the extent that this excerpt might suggest that a patented process can be exhausted even if it is contained in a product with numerous non-infringing uses, we think that is merely erroneous wording by the court. Future cases may clarify the issue more specifically, but the precedent should solidly prevent application of exhaustion in this circumstance.

(1) LG Electronics, Inc. v. Bizcom Electronics Inc., 453 F.3d 1364, 1369-1370 (Fed. Cir. 2006).
(2) See, e.g., Glass Equipment Devel. Inc. v. Besten Inc., 174 F.3d 1337, 1341, n.1 (Fed. Cir. 1999).

About the Author

Mr. Carr is a Counsel at Zuber & Taillieu LLP, where he specializes in patent and trademark prosecution. He earned a J.D. with high honors from Pepperdine University School of Law, and is a member of the California Bar and the U.S. Patent Bar.

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