Supreme Court Extends Exhaustion Doctrine

Supreme Court Finds Sale of Device Extends Patent Exhaustion to Unlicensed Method Claims  

In Quanta Computer, Inc. v. LG Electronics, Inc., 553 U.S. ___; 86 USPQ2d 1673 (June 9, 2008), the Supreme Court held that the doctrine of patent exhaustion applies to unlicensed patented methods used by a sold patented device and that LG’s sale of such devices to Intel, who then sold such devices to Quanta, exhausted LG’s patent rights against downstream purchasers.  The unanimous decision, authored by Justice Thomas, overruled the decision by the Federal Circuit which had held that method patents were not within the scope of the patent exhaustion doctrine.

Background

LG possessed three patents addressing optimization of memory access by a computer processor (the “LG Patents”).  The patents included system claims to a system for ensuring retrieval of current data, a system for the ordering of read and write requests, and a system for managing data traffic on wires connecting computer components (known as a “bus”), and also contained methods claims for the use of the system.  LG entered into a licensing agreement with Intel, authorizing them to practice the system claims (the “License Agreement”).  However, LG stipulated that Intel give notice to its customers that the license did not extend to products made by combining an Intel chip with a non-Intel product, but did not otherwise limit the downstream sale of the Intel chips.  This stipulation was contained in a separate agreement from the licensing agreement, the “Master Agreement,” and explicitly stated that a breach would not affect the License Agreement.

Quanta Computer purchased processor chips from Intel and built computer systems incorporating the chips.  Intel provided Quanta with the required notice and Quanta proceeded to construct computer systems combining the Intel chips with non-Intel components (such as memory, hardware busses, etc).  LG then sued Quanta, alleging infringement of the LG Patents.

The District Court initially ruled in favor of Quanta, granting summary judgment because the doctrine of patent exhaustion prevented LG from asserting its rights to the patents against Quanta.  On reconsideration, the District Court denied summary judgment for Quanta because the LG Patents contained method claims not covered by the licensed system claims.  The Federal Circuit affirmed-in-part and reversed-in-part, agreeing with the District Court that the doctrine of patent exhaustion does not apply to method patents (patents claiming how to make or use a product, as opposed to the product itself).  The Federal Circuit also noted that LG did not license Intel to sell the product for the purposes of combination with non-Intel products such that there was no authorized sale.

Question of Certiorari

Quanta filed a petition for certiorari, which was granted, on the following question:

Whether the Federal Circuit erred by holding, in conflict with the decisions of this Court and other courts of appeals, that respondent’s patent rights were not exhausted by its license agreement with Intel Corporation, and Intel’s subsequent sale of product under the license to petitioners.


The doctrine of patent exhaustion

The Supreme Court reviewed the longstanding doctrine of patent exhaustion, which provides that the initial authorized sale of a patented item terminates all patent rights to that item.  Id at 5; see Bloomer v. McQuewan, 14 How. 539 (U.S. 1853).  “Where a person has purchased a patented machine of the patentee or his assignee, this purchase carries with it the right to the use of that machine so long as it is capable of use.”  Adams v. Burke, 17 Wall. 453 (U.S. 1873).  The Court further reviewed their last decision on the doctrine of patent exhaustion was in United States v. Univis Lens Co.  316 U.S. 241 (1942).  In that case, Univis possessed a patent for a special type of lenses.  Univis sold lens blanks to wholesalers, which the wholesalers would then sell to finishing retailers.  The finishing retailers would then grind down the blanks to produce a patented lens.  Univis attempted to collect further patent royalties from these finishing retailers.  The Supreme Court held that the sale of the lens blanks exhausted the patents on the finished lenses.  As summarized by the Court, Univis stands for the proposition that “the traditional bar on patent restrictions following the sale of an item applies when 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 at 8.

Patent Exhaustion and Method Claims

LG argued, and the District Court and Federal Circuits held, that the doctrine of patent exhaustion does not apply to method claims.  The Supreme Court disagreed for reasons based upon precedent and pointed out the disastrous effects of such an exclusion.

Quanta argued that both the Supreme Court and the Federal Circuit had applied exhaustion to method claims in the past.  The Supreme Court recognized that it has “repeatedly held that method patents were exhausted by the sale of an item that embodied the method.”  Id at 9.  For example, the Court noted that, in Ethyl Gasoline Corp. v. United States, the Court had held that the sale of a motor fuel produced under one patent also exhausted the patent for a method of using the fuel in combustion motors.  309 U.S. 436, 446, 457 (1940); Quanta at 9.

Going further, the Court stated that excluding method claims from the doctrine of patent exhaustion would seriously undermine the doctrine.  If such an exclusion were allowed, patentees seeking to avoid exhaustion would seek to claim a method instead of an apparatus.  Converting an apparatus claim into a method claim is relatively simple, so the effect of such an exclusion would effectively neutralize the doctrine.  The Court further did not see a significant difference between method and apparatus claims that would require an exclusion, and refused to categorically exclude method claims from the doctrine of patent exhaustion when there is a sale of a device covered by corresponding apparatus claims.

Triggering Exhaustion

Having determined that exhaustion applies to method claims, the Court turned to discussing the extent to which a product must embody a patent in order to trigger exhaustion.  Quanta argued that the Court should apply Univis, as the Intel chips here played an analogous role to the lens blanks in that case.  LG sought to distinguish Univis on three grounds: Univis should be limited to physical aspects, the lens blanks and final lenses in Univis were covered by the same patent whereas the Intel chips and systems incorporating the chips were covered by different patents, and that Univis shouldn’t apply as the components here represented parts off a combination patent.

The Court agreed with Quanta, and applied Univis to the facts of the case.  Like the lens blanks in Univis, the only reasonable and intended use of the Intel chips was to practice the LG Patents and the chips sufficiently embodied essential features of the patented invention.  Id at 12.  Univis held that “the 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 at 249.  The Court held that an incomplete article substantially embodies a patent if the only remaining step necessary to fully practice the patent is the application of common processes or the addition of standard parts.  Quanta at 14.  Everything ‘inventive’ about the patent is included in the Intel chips; all that remained for Quanta to do was put it to use by attaching the chips to the standard system components it was designed to use.

Intel’s chip practiced the LG Patents, like the lens blanks in Univis.  Quanta simply finished the product by attaching the required components to it, like the finishing retailers polishing the lens.

The Court rejected LG’s attempts to distinguish Univis. With regards to limiting the holding to physical changes, the Court held that the important component is the nature of the final step, not whether it consists of adding or deleting material.  When the final step to completely practice the patent is common and non-inventive (i.e. grinding the lens or attaching standard components to the processor chip), the incomplete article substantially embodies the patent.

As for LG’s argument that multiple patents covered different elements of the system, the Court agreed with the general principle that practicing one patent should not exhaust another patent.  However, as the Court concluded, the Intel chip substantially embodied the patent LG sought to assert against Quanta and exhausted LG’s rights through the authorized sale of the chip.  While Intel’s chip practiced many other patents fully, there is no reason why it could not also practice (substantially embody) the LG patent in question.  The Court dismissed LG’s combination patent argument as it did not see the combination of components to be the inventive step here.

Exhaustion through Authorized Sale

The Court noted that a patentee’s rights are exhausted against a buyer when the patentee sells a patented product to him.  Further, a patentee’s rights are exhausted against parties who later buy the product from that buyer, provided the patentee authorized the buyer to sell the product.  Here, the Court found that LG authorized Intel to sell chips practicing LG’s patents.  Even though LG required Intel to provide a notice that no license would extend to parties combining the Intel chip with non-Intel parts, Intel was otherwise unconditionally authorized to sell the chips.  There was no breach by Intel as Intel did provide the required notice to LG, thus the sale was authorized per the contract.

LG asserted that Quanta possessed no license to practice its patents, but Quanta argued exhaustion of the patents by sale, not that it was licensed to practice the patent.  The existence of exhaustion turns solely on Intel’s right to sell the patented invention, and the license agreement between Intel and LG makes it clear that Intel’s sale was authorized.  Because the Court found that it is the incomplete article (the Intel chips) that practices the patent, and not the final product (Quanta’s computer system), the Court found LG’s claims barred by exhaustion.  Intel practiced the patent, not Quanta. Quanta’s combination of the Intel chip was simply standard finishing which did not amount to “making” a patented article.

Potential Licensing Exception

While finding the LG patents were exhausted through Intel’s authorized sale, the Court specifically noted that its opinion is directed at patent law.  “The authorized sale of an article that substantially embodies a patent exhausts the patent holder’s rights and prevents the patent holder from invoking patent law to control post-sale use of the article.”  Id at 19 (emphasis added).  The Court also noted that LG is only barred from seeking damages under patent law, but declined to extend their decision to the contractual consequences.  Id at 18 n. 7.  The Court’s dicta seemed to suggest that a patentee’s restitution in similar situations to this lies in the terms of the licensing contracts, with damages being limited to contractual damages.

Conclusion

Intel’s chips “substantially embodied” the LG patents because they had no non-infringing use and included all the inventive aspects of the patents.  Id at 19.  Intel’s authorized sale to Quanta took its products outside the scope of the patent monopoly, barring LG from asserting its patent rights against Quanta through the doctrine of patent exhaustion.  Id.  The chips made by Intel were analogous to Univis’ lens blanks, the sale of which was authorized by LG.  LG’s rights against finishers of Intel’s products are exhausted by the doctrine of patent exhaustion under Univis.

Significance for Patent Owners

Quanta represents a significant limitation to the exhaustion doctrine as it removes one possible set of remedies (i.e., those based upon patent infringement) for unlicensed use of a patented product.  Through Quanta, the Court clarifies that the sale of a product will remove any patent-based infringement theory to the extent that the patent has no other purpose but to be incorporated into the product or a non-inventive use of the product in a particular system.  While seemingly beneficial to end users, the Court does make clear that not all remedies are removed.  Instead, the Court specifically notes that breach of contract remedies should be available.  Thus, while treble damages may not be available due to patent exhaustion, specific performance, damages and other breach of contract claims would survive.  Moreover, given the Court’s emphasis on the fact that the License Agreement did not prohibit the sale of the chips where the customer combined the chips with non-approved products and only required a notice to be provided with the chips, it would be expected that licensors may attempt to cure this deficiency to ensure that the contract does not extend to such situations (thereby emphasizing the unauthorized nature of the initial sale).  As such, it would be expected that patent owners will increasingly look to licensing restrictions to govern end user use of patented items, and will be less reliant on merely selectively licensing patents.

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