Supreme Court Draws Crucial Distinction In Landmark Patent Exhaustion Decision

The Supreme Court's decision in Impression Products, Inc. v. Lexmark International, Inc., 581 U.S. __ (May 30, 2017), is the latest Supreme Court ruling to eviscerate years-long, patentee-friendly Federal Circuit precedent. Issuing less than one week after its decision in TC Heartland LLC v. Kraft Foods Group Brands LLC, 581 U.S. ____ (May 22, 2017) — in which the Supreme Court wiped out 27 years of Federal Circuit precedent by holding that a corporation “resides” for patent litigation venue purposes only in its state of incorporation — the Supreme Court's Impression Products decision further reins in the ability of patent owners to enforce their patent rights by holding that patent exhaustion precludes a patentee from using patent law to enforce post-sale restrictions on products sold by a patentee. (Note: For more on TC Heartland, see, “Supreme Court Turns Back Clock on Venue in Patent Infringement Litigation.”)

While the Impression Products decision is no doubt an unwelcome ruling for patent owners, the decision did confirm a crucial and noteworthy distinction between a patentee's selling of a patented product, which is the focus of the Court's exhaustion ruling, and a patentee's licensing of a patented product. In the latter instance, the Court was clear that a patentee may continue to use patent law to enforce licensing restrictions not only against a licensee, but in certain cases, against a knowing downstream purchaser as well. This article explores this important distinction and addresses how the Court's decision can be used as a guide for drafting patent licenses moving forward.

The Relevant Facts

At issue in Impression Products was whether the patentee, Lexmark, could sue a toner cartridge remanufacturer for patent infringement as a result of the remanufacturer acquiring, refilling and selling used toner cartridges. Slip Op. at 2. Lexmark based its infringement claim on the terms of its toner cartridge “return program,” through which purchasers could acquire new toner cartridges from Lexmark at a 20% discount in exchange for signing a contract agreeing to only a single use of the cartridges and to refrain from transferring the cartridges to anyone other than Lexmark. Id. It was Lexmark's assertion that this express prohibition against the use and resale of “return program” cartridges rendered the remanufacturers liable for patent infringement due to the “unauthorized” nature of their remanufacture and sale. Slip Op. at 3. Lexmark also asserted patent infringement stemming from the import of toner cartridges acquired abroad. Id. In Lexmark's view, the fact that it never authorized its cartridges to be imported meant that the remanufacturer's importation of cartridges violated its U.S. patent rights. Id.

In defense to Lexmark's infringement claims, the remanufacturer asserted that Lexmark's sale of the cartridges exhausted Lexmark's ability to enforce its patent rights against it. Id. The Federal Circuit, however, disagreed. Relying on its 1992 decision in Mallinckrodt, Inc. v. Medipart, Inc., 976 F. 2d 700 (Fed. Cir. 1992), the Federal Circuit held that Lexmark's patent rights in the “return program” cartridges were not exhausted because the “return program's” restriction against resale of the cartridges was “clearly communicated” and known not only to the cartridge purchasers, but to the remanufacturer who subsequently purchased the cartridges. Impression Products, Slip. Op. at 4. In light of these “clearly communicated” restrictions, any subsequent acquisition and sale by the remanufacturers was, according to the Federal Circuit, “without authority” and thus prohibited under the Patent Act. Id. The Federal Circuit also relied on its 2001 decision in Jazz Photo Corp. v. United States International Trade Commission, 264 F.3d 1094 (2001), to find that a patentee's decision to sell a product abroad does not terminate its ability to enforce a patent against a buyer that imports the product in the U.S. Impression Products, Slip Op. at 4.

The Supreme Court's Decision

The Supreme Court disagreed with the Federal Circuit with respect to both the “return program” cartridges and the imported cartridges, holding plainly and simply that “[w]hen a patentee sells one of its products,” whether in the U.S. or abroad, the “patentee can no longer control that item through the patent laws” regardless “of any post-sale restrictions the patentee purports to impose, either directly or through a licensee.” Id. at 1, 13. The Supreme Court's expansive approach to exhaustion is reflective of the common law's resounding “hostility towards restraints on alienation,” where patent rights are viewed as only a narrow exception to the general animosity towards such restraints. Id. at 7. It further contrasted greatly with the understanding of the Federal Circuit, reflected in 25 years of case law, which that court viewed exhaustion as an “interpretation” of what it means to make and sell a patented article “without authority.” Id. at 9. According to the Federal Circuit, a clearly communicated post-sale restriction means any sale in violation of that restriction is “without authority” under the Patent Act. Id. at 10. Thoroughly rejecting that assessment, the Supreme Court pronounced that exhaustion “is not a presumption about the authority that comes along with a sale,” but is a straightforward and uncomplicated “limit on the scope of the patentee's rights.” Id. For that reason, the Supreme Court held that when a patentee sells a patented product, the “purchaser and all subsequent owners are free to use or resell the product just like any other item of personal property, without fear of an infringement suit,” even where restrictions in the patentee's contract for sale are both “clear and enforceable under contract law.” Id. at 1, 5.

As a result of the Impression Products decision, it is apparent that in the Supreme Court's view, any conflict between patent rights and the common law principle disfavoring restraints on trade will result in the latter trumping the former. See, Id. at 6. That said, and as discussed below, the Supreme Court confirmed that notwithstanding its broad exhaustion ruling, a patentee may still be able to rely on patent law to enforce restrictions on sales made by licensees.

The Distinction Between Sales and Licenses

While the Supreme Court could not have been clearer that once a patentee sells a patented product, that sale extinguishes the patentee's rights to enforce its patent — characterizing exhaustion in this instance as “uniform and automatic” — it was equally clear that patent licensees were not subject to the same limitation. Id. at 11, 13. Specifically, the Court acknowledged that if a patentee licenses another entity to make and sell the product, the patentee can use the patent laws to enforce restrictions on the licensee, in some cases even against a downstream purchaser acquiring the product from the licensee.

In drawing a distinction between sales and licenses, the Supreme Court appeared wholly unconcerned with the prospect of creating an “artificial distinction” between the two. Id. at 10. The Court recognized that patentees often “place restrictions on [their] licenses” and are able to “sue the licensee for [patent] infringement” if the licensee fails to comply with the restriction. Id. at 11. But patentees are able to do so, reasoned the Court, because restrictions on licensees do not “implicate the same concerns about restraints on alienation as a sale.” Id. Exhaustion, the Court explained, “reflects the principle that, when an item passes into commerce, it should not be shaded by a legal cloud on title as it moves through the marketplace.” Id. But since a patent license does not pass title to product, it does not fun afoul of this concern. Unlike product sales, patent licenses merely change “the contours of the patentee's monopoly” by “expanding the club of authorized users and sellers.” Id. Since licenses involve only the exchange of “rights” and “not goods,” a patentee is “free to relinquish only a portion” of those rights and to enforce violations through the patent laws. Id.

At first blush, the distinction drawn between sales and licenses may appear to provide a loophole that allows patentees to use patent licenses to impose post-sale restrictions on downstream purchasers that can be enforced through the patent laws. The Supreme Court, however, was quick to dispel this notion by stating that a “patentee's authority to limit licensees does not, as the Federal Circuit thought, mean that patentees can use licenses to impose post-sale restrictions on purchasers that are enforceable through the patent laws.” Id. Although this statement is stated unequivocally, the Court subsequently recognized an instance where a patentee would be able to use the patent laws to enforce license restrictions against downstream purchasers. Specifically, if a patent licensor limits the scope of the license granted, and the licensee exceeds that scope when it sells the patented product, the patentee can sue both the licensee and a knowing purchaser for patent infringement.

This was precisely the situation in General Talking Pictures Corp. v. Western Elec. Co., 305 U.S. 124 (1938), wherein the Supreme Court upheld a patentee's right to sue a downstream purchaser for patent infringement because the patentee had lawfully restricted the scope of the license and both the licensee and its purchaser knew the sale exceeded the license scope. In that case, the patentee had granted a number of patent licenses authorizing the manufacture and sale of patented devices. Id. at 126. Some of the licenses permitted the manufacturer to sell the patented products for commercial use, whereas others limited the sales to private use. Id. One licensee, who was restricted to personal sales only, nevertheless sold the products to a company knowing they were to be used commercially. Id. Likewise, the company purchasing the products knew that the licensee was authorized only for private use sales. Id.

Because the licensee knowingly made the sales to the purchaser “outside the scope of its license,” the Supreme Court found that the patentee could sue its licensee for patent infringement. Id. at 127. The sale was, in essence, “unlicensed” and for that reason, could not work to exhaust the patentee's rights. The Court also found that because the purchaser knew the licensee was not authorized to sell for commercial use, it too could be sued for patent infringement. Id. This principal is consistent with the Supreme Court's proclamation in Quanta Computer, Inc. v. LG Electronics, Inc., 128 S.Ct. 2109, 2121 (2008), that “[e]xhaustion is triggered only by a sale authorized by the patent holder.”

In Impression Products, the Supreme Court did not overrule the holding in General Talking Pictures. To the contrary, the Court expressly confirmed the continued viability of that case, noting that it continues to “stand[] for the modest principal that, if a patentee has not given authority for a licensee to make a sale, that sale cannot exhaust the patentee's rights.” Impression Products, Slip Op. at 12-13.

The Impression Products case thus draws a clear distinction between a patentee's selling of a patented product, in which case exhaustion is triggered automatically, since there is a “sale authorized by the patent holder,” and a patentee's licensing of a patented product, in which case exhaustion may not apply.

Here is an example of how this distinction might work in practice. In a first scenario, a patentee, who manufacturers widgets covered by its patent, sells its widgets to Company A under the express condition that Company A's resales of the widgets are to be limited for use in only certain patentee-approved products. Thereafter, Company A sells a pallet of widgets to Company B knowing Company B will be incorporating the widgets into products that are not patentee-approved. Under Impression Products, patent exhaustion will preclude the patent holder from suing either Company A or Company B for patent infringement, notwithstanding that Company A did not have the patentee's express authority to sell the products at issue to Company B. Exhaustion is triggered because the sale of the product by the patentee to Company A was a patentee-authorized sale.

In a second scenario, instead of selling the widgets to Company A, the patentee grants a license to Company A to manufacture and sell widgets covered by the patentee's patent. The license, however, expressly limits the scope to sales for use in certain patentee-approved products. Company A is thus not licensed to sell widgets for use in any product not on the patentee-approved list. If Company A sells the widgets to Company B, who then uses the widgets in non-approved products, does patent exhaustion apply in this instance?

According to the Impression Products decision, the answer would depend on whether Company A was in compliance with its license when it sold the product to Company B. If, for instance, Company A required Company B to sign an agreement confirming it will only use the widgets in patentee-approved products, and it had no knowledge to the contrary, Company A's sale to Company B would likely be considered within the scope of Company A's license (i.e., “authorized”) and exhaustion would be triggered. In that case, even if Company B proceeded to use the widgets in unauthorized products, the patentee would be without remedy under the patent laws.

If, however, Company A sells the widgets to Company B knowing Company B intends to use the widgets in unauthorized products, Company A's sale would be outside the scope of its license (i.e., not authorized), and the patentee would be able to sue Company A for patent infringement. Likewise, if Company B were aware of the license restriction, it too could be sued for patent infringement.

Takeaway

So how can patent licensors use the Impression Products decision to draft license agreements that will allow them to maintain some control over how their patented products are used and sold? If the agreement involves the patentee selling the patented product, it is hard to imagine any scenario under Impression Products where the patent holder can avoid patent exhaustion. But, if the license agreement is for the manufacture and sale of a patented product, the key may lie in drafting the patent license in such a way that any “restriction” therein concerns the scope of the license granted as opposed to a post-sale use of the patented product.

If, for instance, a patentee grants an unrestricted license to make, use and sell products under the patent, it will be insufficient, under the patent laws, to include within the license (or elsewhere) a restriction as to how the patented product can be sold or used downstream. While such restrictions may be enforceable against the licensee under traditional contract principles, the patentee will be helpless to sue a downstream purchaser for patent infringement even if that downstream purchaser does not comply with the restriction. In that instance, the licensee's sale to the purchaser would be well-within the scope of its license (i.e., authorized), thereby triggering patent exhaustion.

Patent holders should proceed with caution when drafting their patent licenses so that any “restriction” relates to the scope of the license grant itself. This way, a sale by the licensee that exceeds the scope of the license could be met with an action for patent infringement. And if a downstream purchaser is aware that the sale exceeded the license scope, it also could be subject to an action for patent infringement.

***** Robin L. McGrath is a partner in Duane Morris' Atlanta office. She practices in the area of intellectual property law, concentrating on litigating all aspects of patent, trademark and copyright disputes, as well as IP counseling. Disclaimer: This article is prepared and published for informational purposes only and should not be construed as legal advice. The views expressed in this article are those of the author and do not necessarily reflect the views of the author's law firm or its individual partners.