LG Electronics, Inc. v. Bizcom Electronics, Inc.: Guidance on Extending a Patent Holder's Rights to Reach Downstream Parties Who Assemble Components into a Patented Combination

In LG Electronics, Inc. v. Bizcom Electronics, Inc., 453 F.3d 1364 (Fed. Cir. 2006), the Federal Circuit held that a license to a patent covering a combination of elements, that authorized the licensee to sell components of the invention, but disclaimed a downstream license or implied license to the licensees' customers to practice the combination, constituted a conditional sale, thus defeating the application of the patent exhaustion doctrine. It further held that a downstream point of sale notice that no implied license was conveyed similarly defeated the first sale doctrine. In addition, it held that no implied license could be found on those facts. As a result, the patent holder was free to assert a claim of patent infringement against parties who were authorized purchasers of components of its invention, when such parties assembled the resulting combination. This decision provides the clearest guidance to date on how a patent holder whose patents cover a combination of components can extend its rights to reach downstream parties who assemble those components into the patented combination. This article discusses this case in the context of pre-existing authority on patent exhaustion and implied license, and highlights some of the considerations associated with drafting agreements to avoid patent exhaustion and implied licenses.

Patent Exhaustion

During the course of licensing or selling an invention, or components of it, a patentee can surrender its exclusive rights. One way a patent owner can surrender its rights is to make an unconditional and authorized sale of a patented article in the United States. This is called the 'patent exhaustion' or 'first sale' doctrine. Once an unconditional and authorized sale has been made, the purchaser can use, sell, or dispose of the article as it wishes, and the patent owner can reap no further benefit from it, either from that purchaser or one downstream from the purchaser. Jazz Photo Corp. v. International Trade Commission, 264 F.3d 1094, 1105 (Fed. Cir. 2001).

While often discussed in terms of a 'sale,' the patent exhaustion doctrine also applies to the disposition of a product under a license. United States v. Masonite Corp., 316 U.S. 265, 277-78 (1942); LG Electronics, 453 F.3d at 1370.

The Scope of Exhaustion

The earliest cases applied the patent exhaustion doctrine to the sale of patented articles. See, e.g., Adams v. Burke, 84 U.S. 453 (1873); Keeler v. Standard Folding Bed Co., 157 U.S. 659 (1895). The doctrine is also applied when the patentee or licensee makes an unrestricted sale of an article embodying the 'essential elements' of a patent claim. United States v. Univis Lens Co., 316 U.S. 241, 251 (1942) (sale of lens blanks that 'embodies essential features of [the] patented invention' and 'destined the article to be finished ' in conformity [with] the patent.'). In LG Electronics, the Federal Circuit applied the patent exhaustion analysis where there had been a license or sale of microprocessors for use in the patented combinations. 453 F.3d at 1369-70.

Contracting Around Exhaustion

A patentee can contract around the patent exhaustion doctrine by placing conditions on the sale or license. Mallinckrodt v. Medipart, Inc., 976 F.2d 700, 703 (Fed. Cir. 1992). To be valid, a condition must comply with contract laws and not violate antitrust laws, the patent misuse doctrine, or other laws governing competitive conduct. Id. at 703, 709; B. Braun Medical, Inc. v. Abbott Laboratories, 124 F.3d 1419, 1426 (Fed. Cir. 1997). As a general rule, courts will uphold a valid condition imposed by the patentee and agreed to by the purchaser or licensee. Mallinckrodt, 976 F.2d at 703.

Whether a condition (express or implied) exists is governed by ordinary principles of state contract law. Mallinckrodt, 976 F.2d at 709 (establishing principle); LG Electronics, 453 F.3d at 1370 (applying New York law).

For example, in Mallinckrodt, the patentee labeled its patented medical device as 'SINGLE USE ONLY' and instructed hospitals that purchased the devices to dispose of the device after use. 976 F.2d at 702. The Federal Circuit held that if the sale of the device was validly conditioned under the law governing sales and licenses, and if the condition on reuse was within the scope of the patent grant or otherwise justified, then violation of the restriction could be remedied by action for patent infringement. Id. at 709.

Subsequent cases have held that to be valid, a condition must convey 'contractual significance' and not merely the patentee's intent or wishes. Hewlett Packard Co. v. Repeat-O-Type Stencil Mfg. Corp., 123 F.3d 1445, 1453 (Fed. Cir. 1997) (printer manual instructing users to discard used print cartridges did not create enforceable condition); Kendall Co. v. Progressive Medical Technology, Inc., 85 F.3d 1570, 1576 (Fed. Cir. 1996) (single-use only instruction on product literature not condition of sale); Jazz Photo, 264 F.3d at 1108 (package instructions did not create condition on reuse).

While not a patent case, Arizona Cartridge Remanufacturers Ass'n v. Lexmark Int'l, Inc., 421 F.3d 981 (9th Cir. 2005), addresses what creates an enforceable restriction. Lexmark sold printer cartridges with a notice on the cartridge packages that consumers could receive an upfront discount if they agreed to return used cartridges to Lexmark. Id. at 983. The Ninth Circuit discussed the guidance the Federal Circuit provided in Mallinckrodt. Id. at 986-87. It then explained that under California contract law, a 'contract for the sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract.' Id. at 987. The Ninth Circuit held that a notice that included the above-referenced terms was a valid contract, since a consumer could read the terms and decide whether to accept them by participating in the discount program. Id.

One aspect of the LG Electronics decision confirms that the Federal Circuit will conduct a similar analysis. Prior to the litigation, LG and Intel entered into a patent license. LG Elecs., Inc. v. Asustek Computer, Inc., 248 F.Supp.2d 912, 914 (N.D. Cal. 2003). The LG-Intel License expressly disclaimed any license to Intel customers who combine Intel products covered by the LG-Intel License with non-Intel products. Id. Before purchasing the Intel parts that were asserted to be a component of the patented combination, the defendants received a letter from Intel stating that the LG-Intel License 'does not extend, expressly or by implication to any product that you may make by combining an Intel product with any non-Intel product.' Id. The Federal Circuit concluded that the chip set sales by Intel were conditional, citing New York Uniform Commercial Code '2-202 (which it concluded allowed contracts to be supplemented by consistent additional terms unless the writing is intended to be complete and exclusive). LG Electronics, 453 F.3d at 1370.

Additional Limits of Exhaustion

There are some additional limits to the exhaustion doctrine. First, a license or sale only invokes the exhaustion doctrine if it occurs in the United States. Jazz Photo, 264 F.3d at 1105 (limiting first sales under the exhaustion doctrine to those occurring within the United States). Second, the Federal Circuit has held that the patent exhaustion doctrine does not apply to method claims. Bandag, Inc. v. Al Bolser's Tire Stores, Inc., 750 F.2d 903, 924 (Fed. Cir. 1984); LG Electronics, 453 F.3d at 1370.

Summary

Based on the present state of the law on patent exhaustion, the following guiding principles are important to keep in mind in drafting licenses and other contracts:

• The exhaustion doctrine applies only to license or sale in the United States;
• Exhaustion can occur at any step in the chain of commercial transactions that takes place in the United States;
• A patent holder licensing its rights can avoid exhaustion via a license with appropriate scope of use restrictions;
• A patent holder selling a patented product or portion of a patented combination can avoid exhaustion by making use restrictions part of the contract of sale (as determined by the applicable body of state law); and
• Even if exhaustion of apparatus claims has occurred, there will be no exhaustion of method claims.

Implied License

The Scope of the Implied License Doctrine

A patentee can also grant an implied license through its actions. The Federal Circuit has applied the implied license doctrine to the sale of a component used in a patented system or combination. See e.g., Anton/Bauer, Inc. v. PAG, Ltd., 329 F.3d 1343 (Fed. Cir. 2003). In addition, while (as discussed above) the Federal Circuit has concluded that a patentee cannot exhaust its rights in a method patent by license or sale, the Federal Circuit has applied the implied license doctrine to the sale of equipment used to practice a patented method. Bandag, 750 F.2d 903; Met-Coil Sys. Corp. v. Korners Unlimited, Inc., 803 F.2d 684 (Fed. Cir. 1986).

The Federal Circuit has applied a two-part test to determine whether an implied license exists. In order to succeed on an implied license defense, the alleged infringer must show that the purchased article does not have a reasonable non-infringing use, and that the circumstances of the sale plainly indicate that the grant of a license should be inferred. Bandag, 750 F.2d at 925; Met-Coil, 803 F.2d at 686.

The Federal Circuit has broadly interpreted what constitutes a reasonable non-infringing use. For example, in Bandag, the defendant purchased unpatented equipment from a terminated franchisee of the patentee and then used it to practice a patented method. 750 F.2d at 925. While the equipment was specially designed to practice the patented method, the court identified the following non-infringing uses of it: reselling the equipment, modifying it, or using it after the patent expired 18 months later. Id. The court thus held that no implied license had occurred as a result of the sale of the equipment. Id.; see also Glass Equipment Development v. Beaten, Inc., 174 F.3d 1337, 1343 (Fed. Cir. 1999).

Additionally, the alleged infringer must also establish that the circumstances of the sale plainly indicate that the grant of a license should be inferred. Met-Coil, 803 F.2d at 687; Bandag, 750 F.2d at 925. In making this determination, courts rely on principles of equitable estoppel and focus on conduct at the time of the sale. Id. This element is satisfied if the alleged infringer shows that the patentee's actions lead him or her to believe that a license existed and, in reliance, he or she practiced the patent. Id.

An unconditional sale of a product with no non-infringing uses will 'plainly indicate' that an implied license should be inferred. Met-Coil, 803 F.2d at 687; Anton/Bauer, 329 F.3d at 1351-52 (unrestricted sale of one-half of patented battery connector). Similarly, the unconditional sale of a 'machine' useful only in performing a patented process or producing a patented product establishes a prima facie case of an implied license. Met-Coil, 803 F.2d at 687.

In cases where an implied license is found, the court must also determine the scope of the license. Carborundum Co. v. Molten Metal Equipment Innovations, Inc., 72 F.3d 872, 878 (Fed. Cir. 1995). This determination is based on 'what the parties reasonably intended as to the scope of the implied license' based on the circumstances of the sale. Id.

Contracting Around the Implied License Doctrine

In LG Electronics, the Federal Circuit noted that '[r]egardless of any noninfringing uses' no license could be implied because of Intel's express disclaimer to defendants. 453 F.3d at 1369. Specifically, Intel had informed each defendant that Intel's license agreement with LG did not extend to 'any of defendants' products made by combining an Intel product with non-Intel products.' Id. The court found this notice sufficient to prevent an implied license. Id.

Summary

Based on the present state of the law on implied license, the following principles are important in drafting licenses and other contracts:

• An implied license can occur via an unrestricted sale of a component for use in a patented apparatus or combination, or of equipment used to practice a patented method;
• An unrestricted sale giving rise to an implied license can occur at each stage in a chain of commercial transactions; and
• An implied license can be avoided by an effective disclaimer that is in fact delivered not just to the immediate contracting party, but to those downstream from it.

Charlene Morrow is a partner in the Silicon Valley office of Fenwick & West LLP, where she handles trials and appeals in patent and other intellectual property cases. She can be reached at [email protected]. Karen Server is a litigation associate at the firm.

In LG Electronics, Inc. v. Bizcom Electronics, Inc. , 453 F.3d 1364 (Fed. Cir. 2006), the Federal Circuit held that a license to a patent covering a combination of elements, that authorized the licensee to sell components of the invention, but disclaimed a downstream license or implied license to the licensees' customers to practice the combination, constituted a conditional sale, thus defeating the application of the patent exhaustion doctrine. It further held that a downstream point of sale notice that no implied license was conveyed similarly defeated the first sale doctrine. In addition, it held that no implied license could be found on those facts. As a result, the patent holder was free to assert a claim of patent infringement against parties who were authorized purchasers of components of its invention, when such parties assembled the resulting combination. This decision provides the clearest guidance to date on how a patent holder whose patents cover a combination of components can extend its rights to reach downstream parties who assemble those components into the patented combination. This article discusses this case in the context of pre-existing authority on patent exhaustion and implied license, and highlights some of the considerations associated with drafting agreements to avoid patent exhaustion and implied licenses.

Patent Exhaustion

During the course of licensing or selling an invention, or components of it, a patentee can surrender its exclusive rights. One way a patent owner can surrender its rights is to make an unconditional and authorized sale of a patented article in the United States. This is called the 'patent exhaustion' or 'first sale' doctrine. Once an unconditional and authorized sale has been made, the purchaser can use, sell, or dispose of the article as it wishes, and the patent owner can reap no further benefit from it, either from that purchaser or one downstream from the purchaser. Jazz Photo Corp. v. International Trade Commission , 264 F.3d 1094, 1105 (Fed. Cir. 2001).

While often discussed in terms of a 'sale,' the patent exhaustion doctrine also applies to the disposition of a product under a license. United States v. Masonite Corp. , 316 U.S. 265, 277-78 (1942); LG Electronics, 453 F.3d at 1370.

The Scope of Exhaustion

The earliest cases applied the patent exhaustion doctrine to the sale of patented articles. See, e.g., Adams v. Burke , 84 U.S. 453 (1873); Keeler v. Standard Folding Bed Co ., 157 U.S. 659 (1895). The doctrine is also applied when the patentee or licensee makes an unrestricted sale of an article embodying the 'essential elements' of a patent claim. United States v. Univis Lens Co. , 316 U.S. 241, 251 (1942) (sale of lens blanks that 'embodies essential features of [the] patented invention' and 'destined the article to be finished ' in conformity [with] the patent.'). In LG Electronics, the Federal Circuit applied the patent exhaustion analysis where there had been a license or sale of microprocessors for use in the patented combinations. 453 F.3d at 1369-70.

Contracting Around Exhaustion

A patentee can contract around the patent exhaustion doctrine by placing conditions on the sale or license. Mallinckrodt v. Medipart , Inc., 976 F.2d 700, 703 (Fed. Cir. 1992). To be valid, a condition must comply with contract laws and not violate antitrust laws, the patent misuse doctrine, or other laws governing competitive conduct. Id. at 703, 709; B. Braun Medical, Inc. v. Abbott Laboratories , 124 F.3d 1419, 1426 (Fed. Cir. 1997). As a general rule, courts will uphold a valid condition imposed by the patentee and agreed to by the purchaser or licensee. Mallinckrodt, 976 F.2d at 703.

Whether a condition (express or implied) exists is governed by ordinary principles of state contract law. Mallinckrodt, 976 F.2d at 709 (establishing principle); LG Electronics, 453 F.3d at 1370 (applying New York law).

For example, in Mallinckrodt, the patentee labeled its patented medical device as 'SINGLE USE ONLY' and instructed hospitals that purchased the devices to dispose of the device after use. 976 F.2d at 702. The Federal Circuit held that if the sale of the device was validly conditioned under the law governing sales and licenses, and if the condition on reuse was within the scope of the patent grant or otherwise justified, then violation of the restriction could be remedied by action for patent infringement. Id. at 709.

Subsequent cases have held that to be valid, a condition must convey 'contractual significance' and not merely the patentee's intent or wishes. Hewlett Packard Co. v. Repeat-O-Type Stencil Mfg. Corp. , 123 F.3d 1445, 1453 (Fed. Cir. 1997) (printer manual instructing users to discard used print cartridges did not create enforceable condition); Kendall Co. v. Progressive Medical Technology, Inc. , 85 F.3d 1570, 1576 (Fed. Cir. 1996) (single-use only instruction on product literature not condition of sale); Jazz Photo, 264 F.3d at 1108 (package instructions did not create condition on reuse).

While not a patent case, Arizona Cartridge Remanufacturers Ass'n v. Lexmark Int'l, Inc., 421 F.3d 981 (9th Cir. 2005), addresses what creates an enforceable restriction. Lexmark sold printer cartridges with a notice on the cartridge packages that consumers could receive an upfront discount if they agreed to return used cartridges to Lexmark. Id. at 983. The Ninth Circuit discussed the guidance the Federal Circuit provided in Mallinckrodt. Id. at 986-87. It then explained that under California contract law, a 'contract for the sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract.' Id. at 987. The Ninth Circuit held that a notice that included the above-referenced terms was a valid contract, since a consumer could read the terms and decide whether to accept them by participating in the discount program. Id.

One aspect of the LG Electronics decision confirms that the Federal Circuit will conduct a similar analysis. Prior to the litigation, LG and Intel entered into a patent license. LG Elecs., Inc. v. Asustek Computer, Inc. , 248 F.Supp.2d 912, 914 (N.D. Cal. 2003). The LG-Intel License expressly disclaimed any license to Intel customers who combine Intel products covered by the LG-Intel License with non-Intel products. Id. Before purchasing the Intel parts that were asserted to be a component of the patented combination, the defendants received a letter from Intel stating that the LG-Intel License 'does not extend, expressly or by implication to any product that you may make by combining an Intel product with any non-Intel product.' Id. The Federal Circuit concluded that the chip set sales by Intel were conditional, citing New York Uniform Commercial Code '2-202 (which it concluded allowed contracts to be supplemented by consistent additional terms unless the writing is intended to be complete and exclusive). LG Electronics, 453 F.3d at 1370.

Additional Limits of Exhaustion

There are some additional limits to the exhaustion doctrine. First, a license or sale only invokes the exhaustion doctrine if it occurs in the United States. Jazz Photo, 264 F.3d at 1105 (limiting first sales under the exhaustion doctrine to those occurring within the United States). Second, the Federal Circuit has held that the patent exhaustion doctrine does not apply to method claims. Bandag, Inc. v. Al Bolser's Tire Stores, Inc. , 750 F.2d 903, 924 (Fed. Cir. 1984); LG Electronics, 453 F.3d at 1370.

Summary

Based on the present state of the law on patent exhaustion, the following guiding principles are important to keep in mind in drafting licenses and other contracts:

• The exhaustion doctrine applies only to license or sale in the United States;
• Exhaustion can occur at any step in the chain of commercial transactions that takes place in the United States;
• A patent holder licensing its rights can avoid exhaustion via a license with appropriate scope of use restrictions;
• A patent holder selling a patented product or portion of a patented combination can avoid exhaustion by making use restrictions part of the contract of sale (as determined by the applicable body of state law); and
• Even if exhaustion of apparatus claims has occurred, there will be no exhaustion of method claims.

Implied License

The Scope of the Implied License Doctrine

A patentee can also grant an implied license through its actions. The Federal Circuit has applied the implied license doctrine to the sale of a component used in a patented system or combination. See e.g., Anton/Bauer, Inc. v. PAG, Ltd. , 329 F.3d 1343 (Fed. Cir. 2003). In addition, while (as discussed above) the Federal Circuit has concluded that a patentee cannot exhaust its rights in a method patent by license or sale, the Federal Circuit has applied the implied license doctrine to the sale of equipment used to practice a patented method. Bandag, 750 F.2d 903; Met-Coil Sys. Corp. v. Korners Unlimited, Inc. , 803 F.2d 684 (Fed. Cir. 1986).

The Federal Circuit has applied a two-part test to determine whether an implied license exists. In order to succeed on an implied license defense, the alleged infringer must show that the purchased article does not have a reasonable non-infringing use, and that the circumstances of the sale plainly indicate that the grant of a license should be inferred. Bandag, 750 F.2d at 925; Met-Coil, 803 F.2d at 686.

The Federal Circuit has broadly interpreted what constitutes a reasonable non-infringing use. For example, in Bandag, the defendant purchased unpatented equipment from a terminated franchisee of the patentee and then used it to practice a patented method. 750 F.2d at 925. While the equipment was specially designed to practice the patented method, the court identified the following non-infringing uses of it: reselling the equipment, modifying it, or using it after the patent expired 18 months later. Id. The court thus held that no implied license had occurred as a result of the sale of the equipment. Id.; see also Glass Equipment Development v. Beaten, Inc., 174 F.3d 1337, 1343 (Fed. Cir. 1999).

Additionally, the alleged infringer must also establish that the circumstances of the sale plainly indicate that the grant of a license should be inferred. Met-Coil, 803 F.2d at 687; Bandag, 750 F.2d at 925. In making this determination, courts rely on principles of equitable estoppel and focus on conduct at the time of the sale. Id. This element is satisfied if the alleged infringer shows that the patentee's actions lead him or her to believe that a license existed and, in reliance, he or she practiced the patent. Id.

An unconditional sale of a product with no non-infringing uses will 'plainly indicate' that an implied license should be inferred. Met-Coil, 803 F.2d at 687; Anton/Bauer, 329 F.3d at 1351-52 (unrestricted sale of one-half of patented battery connector). Similarly, the unconditional sale of a 'machine' useful only in performing a patented process or producing a patented product establishes a prima facie case of an implied license. Met-Coil, 803 F.2d at 687.

In cases where an implied license is found, the court must also determine the scope of the license. Carborundum Co. v. Molten Metal Equipment Innovations, Inc. , 72 F.3d 872, 878 (Fed. Cir. 1995). This determination is based on 'what the parties reasonably intended as to the scope of the implied license' based on the circumstances of the sale. Id.

Contracting Around the Implied License Doctrine

In LG Electronics, the Federal Circuit noted that '[r]egardless of any noninfringing uses' no license could be implied because of Intel's express disclaimer to defendants. 453 F.3d at 1369. Specifically, Intel had informed each defendant that Intel's license agreement with LG did not extend to 'any of defendants' products made by combining an Intel product with non-Intel products.' Id. The court found this notice sufficient to prevent an implied license. Id.

Summary

Based on the present state of the law on implied license, the following principles are important in drafting licenses and other contracts:

• An implied license can occur via an unrestricted sale of a component for use in a patented apparatus or combination, or of equipment used to practice a patented method;
• An unrestricted sale giving rise to an implied license can occur at each stage in a chain of commercial transactions; and
• An implied license can be avoided by an effective disclaimer that is in fact delivered not just to the immediate contracting party, but to those downstream from it.

Charlene Morrow is a partner in the Silicon Valley office of Fenwick & West LLP, where she handles trials and appeals in patent and other intellectual property cases. She can be reached at [email protected]. Karen Server is a litigation associate at the firm.