<i>Quanta Computer, Inc., et al. v. LG Electronics, Inc.</i>

License Agreements

LG licensed the LG Patents to Intel Corporation (the 'License Agreement'). The License Agreement unconditionally authorized Intel to ”make, use, sell (directly or indirectly), offer to sell, import or otherwise dispose of' its own products practicing' the LG Patents. Quanta, 128 S.Ct. at 2114. However, the License Agreement specified that 'no license is granted ' to any third party for the combination by a third party of Licensed Products of [Intel] with items, components or the like acquired ' from sources other than [Intel], or for the use, import, offer for sale or sale of such combination.' Id. On the other hand, the License Agreement expressly stated that it did not 'limit or alter the effect of patent exhaustion that would otherwise apply when [Intel] sells any of its Licensed Products.' Id.

Pursuant to a separate agreement (the 'Master Agreement'), Intel agreed to provide written notice to its customers informing them that the License Agreement from LG 'does not extend, expressly or by implication, to any product that [a subsequent purchaser] make[s] by combining an Intel product with any non-Intel product.' On the other hand, the Master Agreement also contained a separate clause indicating that breach of the Master Agreement would 'have no effect on and shall not be grounds for termination of the Patent License' from LG to Intel. Id.

Quanta Computer purchased the Intel Chips from Intel and received the notice required by the Master Agreement. Id. at 2115. The 'only reasonable and intended use [for the Intel Chips] was to practice the [LG Patents].' Id. at 2219. They were 'specifically designed to function only when memory or buses are attached.' Id. at 2120. 'Intel all but practiced the patent itself by designing its products to practice the patents, lacking only the addition of standard parts.' Id. at 2120. Quanta then manufactured computers by combining both the Intel Chips with non-Intel wires, buses and memory chips pursuant to Intel's specifications in such a way that the assembled computer practiced the LG Patents. At issue was whether those computers infringed the LG Patents or whether Intel's sale of the Intel Chips exhausted LG's patent rights to patents covering a system containing those chips and other components.

The District Court Decision

LG filed a complaint against Quanta asserting that the combination of the Intel Chips with non-Intel (unlicensed) components (e.g., buses or memory devices) infringed the LG Patents on the combined products. Quanta moved for partial summary judgment of noninfringement and argued that one or both of the related doctrines of patent exhaustion or implied license applied as a defense.

The district court held that the patent exhaustion doctrine applied to the sale of unpatented items (the Intel Chips) because the Intel Chips had no other function but as components in a finished, patented device. LG Elecs., Inc. v. Asustek Computer, Inc., 65 U.S.P.Q.2d 1589, 1598 (N.D. Cal. 2002) The district court relied on the Supreme Court's holding in United States v. Univis Lens Co., 316 U.S. 241 (1942) to find that 'the Intel microprocessors and chipsets are designed and intended by Intel to be used in computers in accordance with Intel's technical specification and that such use is the sole contemplated use for the devices.' Id. at 1599. Therefore, the court found, LG's patents were exhausted by Intel's authorized sale of the Intel Chips.

The Federal Circuit Decision

The Federal Circuit disagreed. See Quanta Computer, Inc. v. LG Elecs., Inc., 453 F.3d 1364 (Fed. Cir. 2006). It found that the sale of the Intel Chips was conditioned on an agreement not to combine those chips with non-Intel products. It relied on the express disclaimer in the License Agreement prohibiting any 'implied license' to third parties and reversed the lower court's finding of 'exhaustion.' It noted that the exhaustion doctrine does not apply to an expressly conditioned sale or license, nor to method patents. Id. at 1370. The Federal Circuit also noted that although the license to Intel constituted a 'sale' for exhaustion purposes, the sale by Intel to each defendant involved only a component of the asserted patented system and not the entire patented system. Therefore, the Federal Circuit found that the patents, which covered the combination of the Licensed Intel Products with other products, were not exhausted. Id.

The Supreme Court's Analysis

The Supreme Court agreed with Quanta that Univis governed the case and rejected LG's argument that the sale to Intel of components did not exhaust the patents in those components because the patents did not completely embody the patented invention. Rather, as in Univis, the Court found that exhaustion occurs so long as the item sufficiently embodies the patent, even if it does not completely practice the patent, such that its only and intended use is to be finished under the terms of the patent. Quanta, 128 S.Ct. at 2117. Relying on Univis, the Court found that the sale of the components did exhaust the LG Patents because: 1) the only reasonable and intended use of the unpatented products was to practice the patent; and 2) the unpatented components 'embodied essential features of the patented invention'. Id. at 2119 (emphasis added).

The Court found that like the product at issue in Univis, the Intel Chips substantially embodied the patented invention and all but completely practiced the LG Patents because the 'only step necessary to practice the patent is the application of common processes or the addition of standard parts.' The Court found that everything 'inventive about each patent' is embodied in the Intel Chips. Id. at 2120. It also found that the Intel Chips cannot carry out their basic functions unless they are attached to standard components like memory and buses and Quanta was not required to make any creative or inventive decision when adding the Intel Chips to the non-Intel components.

Although the Supreme Court agreed with the general principle that exhaustion does not apply across patents, the Court rejected LG's argument that since the products were covered by multiple patents, patent exhaustion would not apply. Under the Court's analysis, the relevant consideration is whether a product that partially practices a patent embodies that patent's essential features, has no other reasonable use, and therefore exhausts that patent. Id. at 2119-2121.

The Court also rejected LG's argument that method claims, as a category, are never exhaustible. Id. at 2118. The Court found that both an apparatus and method claim 'may approach each other so nearly that it will be difficult to distinguish the process from the function of the apparatus.' Id. at 2118. The Court noted that although patented methods may not be sold in the same way as an article or device, methods nonetheless may be embodied in a product, the sale of which then exhausts patent rights. Id. at 2117, citing Ethyl Gasoline Corp. v. United States, 309 U.S. 436, 446, 457 (1940) (sale of motor fuel produced under one patent also exhausted the patent for a method of using that fuel in combustion motors); Univis, 316 U.S. at 248-251 (sale of optical lens blanks that partially practiced a patent exhausted the method patents that were not completely practiced until the lens blanks were ground into lenses using commonly available techniques). The Court cautioned that the insertion of a method claim for the machine's 'patented method of performing its task' should not be used to shield the patent from exhaustion. Quanta, 128 S.Ct. at 2118. Interpreting the Court's use of the phrase 'as a category' and noting that the Court based its analysis on method of use cases, Quanta might be construed not to exhaust all patented method claims covering the sale of a product, but rather read narrowly to apply only to method of use patents. Because Quanta does not specifically address cases in which there are reasonable noninfringing uses of an article, it is possible that a sale might not exhaust the patented use. Also not specifically addressed is whether Quanta applies to method of manufacturing patents where the 'making' involves more than the addition of standard parts or processes or where the 'making' can be done in either the patented or unpatented ways.

Conclusion: Restrictive
Licenses Seem to Survive

The Quanta decision does not expressly disturb, and arguably does not impliedly disturb, the holding of Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992). Under Mallinckrodt, unless a condition of sale violates some other law or policy, such as patent misuse or antitrust law, private parties are free to restrict by contract the extent patent rights flow with the sale of goods. Mallinckrodt, 976 F.2d at 708. However, Mallinckrodt acknowledges that authorized, unconditional sales of a patented device exhaust the patentee's right to control the purchaser's use of the device. B. Braun Medical, Inc. v. Abbott Lab., 124 F.3d 1419, 1426 (Fed. Cir. 1997).

The Mallinckrodt court relied on the General Talking Pictures decision for its holding. General Talking Pictures Corp. v. Western Elec. Co., 304 U.S. 175 (1938), aff'd on reh'g, 305 U.S. 124 (1938). The Quanta Court distinguished General Talking Pictures by citing to factual aspects unique to the structure of the Intel-LG license transaction. As discussed above, the Quanta Court found that nothing in the agreement between LG and Intel restricted Intel's rights to sell the Intel Chips to purchasers who intended to combine them with non-Intel parts, even though the resulting combination would be within the scope of LG's patents. Thus, the Supreme Court found that Intel's sale of the Intel Chips to Quanta was authorized. The Court ruled that because Intel was authorized to sell the unpatented Intel Chips to Quanta, the doctrine of patent exhaustion prevented LG from asserting its patent rights against Quanta computers practicing the LG Patents, which were substantially embodied by the Intel Chips.

However, despite the expectations of many observers, and the many amici curiae, Quanta did not discuss the extent to which a party can contractually restrict downstream application of the patent exhaustion doctrine.

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Matthew W. Siegal is a Partner in the Intellectual Property Practice Group of Stroock & Stroock & Lavan LLP and Kevin C. Ecker is an associate in Stroock's Intellectual Property Practice Group. The opinions expressed are those of the authors and do not necessarily reflect the views of their firm or any of its clients. On June 9, 2008, the United States Supreme Court issued its long-awaited decision in Quanta Computer, Inc. v. LG Elecs., Inc. , 128 S.Ct. 2109 (2008). (' Quanta '). Many observers believed that the Court would address whether, and to what extent, a party can contractually restrict application of the patent exhaustion doctrine, under which patent rights covering a product are extinguished when the product is sold without restriction. Instead, the Court's decision in Quanta appears to be relatively narrow, confirming that the sale of unpatented components can exhaust a system patent that is substantially, but not completely, embodied by those components, but leaving open the broader question of whether parties can contractually limit application of the patent exhaustion doctrine to the detriment of downstream good faith purchasers.

This article provides background and context as to how the Quanta case arose, examines the district court and Federal Circuit decisions in that case, and discusses the Supreme Court's analysis and holding, including the apparently limited scope of the Quanta decision.

Background: The Patents at Issue

Respondent LG Electronics Inc. ('LG') is the owner of the three patents at issue: U.S. Patent Nos. 4,939,641 (the ”641 patent'); 5,379,379 (the ”379 patent'); and 5,077,733 (the ”733 patent') (collectively, the 'LG Patents'). The '641 and '379 patents relate to systems whereby a microprocessor writes or reads data to or from memory. See LG Elecs., Inc. v. Bizcom Elecs., Inc. , 453 F.3d 1364, 1377-78 (Fed. Cir. 2006). The '733 patent addresses a problem of resource allocation and provides a rotating priority system under which each device ' such as a
keyboard, monitor, mouse, hard drive and memory ' has priority access for a preset period of time to the data bus connecting the microprocessor seated in the chipset. Intel sold Quanta chips and microprocessors (the 'Intel Chips'), but not the standard hardware (e.g., buses and memory units) used to connect the Intel Chips in a working computer. None of the Intel Chips infringed the LG Patents until assembled with that hardware into a computer.

License Agreements

LG licensed the LG Patents to Intel Corporation (the 'License Agreement'). The License Agreement unconditionally authorized Intel to ”make, use, sell (directly or indirectly), offer to sell, import or otherwise dispose of' its own products practicing' the LG Patents. Quanta, 128 S.Ct. at 2114. However, the License Agreement specified that 'no license is granted ' to any third party for the combination by a third party of Licensed Products of [Intel] with items, components or the like acquired ' from sources other than [Intel], or for the use, import, offer for sale or sale of such combination.' Id. On the other hand, the License Agreement expressly stated that it did not 'limit or alter the effect of patent exhaustion that would otherwise apply when [Intel] sells any of its Licensed Products.' Id.

Pursuant to a separate agreement (the 'Master Agreement'), Intel agreed to provide written notice to its customers informing them that the License Agreement from LG 'does not extend, expressly or by implication, to any product that [a subsequent purchaser] make[s] by combining an Intel product with any non-Intel product.' On the other hand, the Master Agreement also contained a separate clause indicating that breach of the Master Agreement would 'have no effect on and shall not be grounds for termination of the Patent License' from LG to Intel. Id.

Quanta Computer purchased the Intel Chips from Intel and received the notice required by the Master Agreement. Id. at 2115. The 'only reasonable and intended use [for the Intel Chips] was to practice the [LG Patents].' Id. at 2219. They were 'specifically designed to function only when memory or buses are attached.' Id. at 2120. 'Intel all but practiced the patent itself by designing its products to practice the patents, lacking only the addition of standard parts.' Id. at 2120. Quanta then manufactured computers by combining both the Intel Chips with non-Intel wires, buses and memory chips pursuant to Intel's specifications in such a way that the assembled computer practiced the LG Patents. At issue was whether those computers infringed the LG Patents or whether Intel's sale of the Intel Chips exhausted LG's patent rights to patents covering a system containing those chips and other components.

The District Court Decision

LG filed a complaint against Quanta asserting that the combination of the Intel Chips with non-Intel (unlicensed) components (e.g., buses or memory devices) infringed the LG Patents on the combined products. Quanta moved for partial summary judgment of noninfringement and argued that one or both of the related doctrines of patent exhaustion or implied license applied as a defense.

The district court held that the patent exhaustion doctrine applied to the sale of unpatented items (the Intel Chips) because the Intel Chips had no other function but as components in a finished, patented device. LG Elecs., Inc. v. Asustek Computer, Inc. , 65 U.S.P.Q.2d 1589, 1598 (N.D. Cal. 2002) The district court relied on the Supreme Court's holding in United States v. Univis Lens Co. , 316 U.S. 241 (1942) to find that 'the Intel microprocessors and chipsets are designed and intended by Intel to be used in computers in accordance with Intel's technical specification and that such use is the sole contemplated use for the devices.' Id. at 1599. Therefore, the court found, LG's patents were exhausted by Intel's authorized sale of the Intel Chips.

The Federal Circuit Decision

The Federal Circuit disagreed. See Quanta Computer, Inc. v. LG Elecs., Inc. , 453 F.3d 1364 (Fed. Cir. 2006). It found that the sale of the Intel Chips was conditioned on an agreement not to combine those chips with non-Intel products. It relied on the express disclaimer in the License Agreement prohibiting any 'implied license' to third parties and reversed the lower court's finding of 'exhaustion.' It noted that the exhaustion doctrine does not apply to an expressly conditioned sale or license, nor to method patents. Id. at 1370. The Federal Circuit also noted that although the license to Intel constituted a 'sale' for exhaustion purposes, the sale by Intel to each defendant involved only a component of the asserted patented system and not the entire patented system. Therefore, the Federal Circuit found that the patents, which covered the combination of the Licensed Intel Products with other products, were not exhausted. Id.

The Supreme Court's Analysis

The Supreme Court agreed with Quanta that Univis governed the case and rejected LG's argument that the sale to Intel of components did not exhaust the patents in those components because the patents did not completely embody the patented invention. Rather, as in Univis, the Court found that exhaustion occurs so long as the item sufficiently embodies the patent, even if it does not completely practice the patent, such that its only and intended use is to be finished under the terms of the patent. Quanta, 128 S.Ct. at 2117. Relying on Univis, the Court found that the sale of the components did exhaust the LG Patents because: 1) the only reasonable and intended use of the unpatented products was to practice the patent; and 2) the unpatented components 'embodied essential features of the patented invention'. Id. at 2119 (emphasis added).

The Court found that like the product at issue in Univis, the Intel Chips substantially embodied the patented invention and all but completely practiced the LG Patents because the 'only step necessary to practice the patent is the application of common processes or the addition of standard parts.' The Court found that everything 'inventive about each patent' is embodied in the Intel Chips. Id. at 2120. It also found that the Intel Chips cannot carry out their basic functions unless they are attached to standard components like memory and buses and Quanta was not required to make any creative or inventive decision when adding the Intel Chips to the non-Intel components.

Although the Supreme Court agreed with the general principle that exhaustion does not apply across patents, the Court rejected LG's argument that since the products were covered by multiple patents, patent exhaustion would not apply. Under the Court's analysis, the relevant consideration is whether a product that partially practices a patent embodies that patent's essential features, has no other reasonable use, and therefore exhausts that patent. Id. at 2119-2121.

The Court also rejected LG's argument that method claims, as a category, are never exhaustible. Id. at 2118. The Court found that both an apparatus and method claim 'may approach each other so nearly that it will be difficult to distinguish the process from the function of the apparatus.' Id. at 2118. The Court noted that although patented methods may not be sold in the same way as an article or device, methods nonetheless may be embodied in a product, the sale of which then exhausts patent rights. Id . at 2117, citing Ethyl Gasoline Corp. v. United States , 309 U.S. 436, 446, 457 (1940) (sale of motor fuel produced under one patent also exhausted the patent for a method of using that fuel in combustion motors); Univis, 316 U.S. at 248-251 (sale of optical lens blanks that partially practiced a patent exhausted the method patents that were not completely practiced until the lens blanks were ground into lenses using commonly available techniques). The Court cautioned that the insertion of a method claim for the machine's 'patented method of performing its task' should not be used to shield the patent from exhaustion. Quanta, 128 S.Ct. at 2118. Interpreting the Court's use of the phrase 'as a category' and noting that the Court based its analysis on method of use cases, Quanta might be construed not to exhaust all patented method claims covering the sale of a product, but rather read narrowly to apply only to method of use patents. Because Quanta does not specifically address cases in which there are reasonable noninfringing uses of an article, it is possible that a sale might not exhaust the patented use. Also not specifically addressed is whether Quanta applies to method of manufacturing patents where the 'making' involves more than the addition of standard parts or processes or where the 'making' can be done in either the patented or unpatented ways.

Conclusion: Restrictive
Licenses Seem to Survive

The Quanta decision does not expressly disturb, and arguably does not impliedly disturb, the holding of Mallinckrodt, Inc. v. Medipart, Inc. , 976 F.2d 700 (Fed. Cir. 1992). Under Mallinckrodt, unless a condition of sale violates some other law or policy, such as patent misuse or antitrust law, private parties are free to restrict by contract the extent patent rights flow with the sale of goods. Mallinckrodt, 976 F.2d at 708. However, Mallinckrodt acknowledges that authorized, unconditional sales of a patented device exhaust the patentee's right to control the purchaser's use of the device. B. Braun Medical, Inc. v. Abbott Lab. , 124 F.3d 1419, 1426 (Fed. Cir. 1997).

The Mallinckrodt court relied on the General Talking Pictures decision for its holding. General Talking Pictures Corp. v. Western Elec. Co. , 304 U.S. 175 (1938), aff'd on reh'g , 305 U.S. 124 (1938). The Quanta Court distinguished General Talking Pictures by citing to factual aspects unique to the structure of the Intel-LG license transaction. As discussed above, the Quanta Court found that nothing in the agreement between LG and Intel restricted Intel's rights to sell the Intel Chips to purchasers who intended to combine them with non-Intel parts, even though the resulting combination would be within the scope of LG's patents. Thus, the Supreme Court found that Intel's sale of the Intel Chips to Quanta was authorized. The Court ruled that because Intel was authorized to sell the unpatented Intel Chips to Quanta, the doctrine of patent exhaustion prevented LG from asserting its patent rights against Quanta computers practicing the LG Patents, which were substantially embodied by the Intel Chips.

However, despite the expectations of many observers, and the many amici curiae, Quanta did not discuss the extent to which a party can contractually restrict downstream application of the patent exhaustion doctrine.

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Matthew W. Siegal is a Partner in the Intellectual Property Practice Group of Stroock & Stroock & Lavan LLP and Kevin C. Ecker is an associate in Stroock's Intellectual Property Practice Group. The opinions expressed are those of the authors and do not necessarily reflect the views of their firm or any of its clients.