Editor’s note: Brad Evans is a member of the Litigation and Intellectual Property Practice Groups at Ward and Smith, P.A.

"Downstream" Patent Rights

Patent holders possess a valuable right. It is the right to prevent others from using the patent holder’s product without permission. Patent holders have the exclusive right to sell, or license, the patented product to others ("first tier purchasers"). But does a patent holder have a "patent" right to prevent those who purchase or license use of a product made by the first tier purchaser and derived in part from the patent ("downstream purchasers") from selling a product the downstream purchaser creates using the first tier purchaser’s product? No, according to the United States Supreme Court in Quanta Computer, Inc. v. LG Electronics, Inc. The Court’s ruling underscores the continued viability of the longstanding doctrine of patent exhaustion (also known as the "first sale doctrine"), as well as the importance of using only carefully drafted contracts in connection with the transfer and use of patented products.

In short, the Court held that downstream purchasers can buy patented goods and resell them with no "patent strings" attached. However, the Court hinted that this area may be prime territory for artful legal drafting that could leave "contract strings" intact well beyond the first tier purchaser.

The Court’s Ruling in Quanta

In Quanta, LGE, a patent holder, licensed certain patents to Intel, a first tier purchaser. The license agreement did not reference the doctrine of patent exhaustion. A separate agreement between LGE and Intel did require Intel to give its customers written notice that Intel’s license did not extend to products made by combining Intel products with non-Intel products.

Quanta purchased certain products from Intel that embodied LGE’s patents, making Quanta a downstream purchaser. Quanta then combined the licensed Intel products with non-Intel products and offered them for sale. LGE sued, alleging that Quanta’s combination of the products infringed on LGE’s patents.

The Court held that the doctrine of patent exhaustion barred LGE’s claims against Quanta. The Court first held that the doctrine of patent exhaustion applies to "method patents," the particular type of patent at issue in the case. This was an important holding because, previously, some patent holders classified their patents as method patents because there was some question as to whether the patent exhaustion doctrine applied to that type of patent.

The Court then noted that the patent exhaustion doctrine applies only where the sale of the patented item is "authorized" by the patent holder. While LGE argued that the sale by Intel to Quanta was not authorized, the Court found that there was nothing in the license agreement that restricted Intel’s right to sell its products. Similarly, the separate agreement requiring Intel to give notice to its customers that its license of the LGE patent did not extend to combined products did not restrict Intel’s sales rights; it merely required that the specified notice be given. Thus, the Court found the sale from Intel to Quanta to be an "authorized sale" under the patent exhaustion doctrine because it was not forbidden and that the patent exhaustion doctrine therefore barred LGE’s infringement claims.

Although the Court closed a door on patent holders with its reaffirmation of the patent exhaustion doctrine, it recognized the possibility that a window could be opened by the use of artful legal drafting. In his opinion for the unanimous Court, Justice Clarence Thomas emphasized the fact that neither LGE’s license agreement nor its separate contract requiring Intel to give notice of the limited nature of Intel’s license contained language that would make Intel’s sale to Quanta "unauthorized." This suggests that the opportunity exists for patent holders to contract with first tier purchasers in a manner that will make resale of the patented product by a downstream purchaser unauthorized. In a footnote, the Court further noted that even where a sale is authorized, thereby invoking the patent exhaustion doctrine, that doctrine may not limit the patent holder’s separate contractual rights. While the Court expressed no opinion on this issue, the footnote highlights the possibility that a carefully drafted contract may provide a patent holder who authorizes a sale with an action for breach of contract against the patent holder’s first tier purchaser, the downstream purchaser, or, depending on how well the contract is negotiated and drafted, both.

Application to Copyrights and Trademarks

The holding of Quanta may extend beyond patent rights and into other areas of intellectual property. In Vernor v. Autodesk, Inc., an opinion that pre-dated Quanta, a federal district court in the state of Washington ruled that a first sale of copyrighted material similarly exhausted the copyright holder’s distribution rights under the federal Copyright Act. However, before you begin selling copies of your vintage album collection, note that this court (1) recognized a split in authority over what constitutes a "sale" of licensed material under the Copyright Act and (2) pointed out that the first sale doctrine exhausted only a copyright holder’s distribution rights, not other rights such as the right to prohibit further copying. Further, at least one other federal court has reached a different result in a trademark infringement case where exhaustion was in issue, although the misleading conduct of the accused infringer appeared to be the determinative factor in that case.

Conclusion

The reaffirmation of the patent exhaustion, or first sale, doctrine in Quanta should spur intellectual property owners to be diligent in their license negotiations. Regardless of the particular nature of the patent, copyright, or trademark at issue, the effects of the exhaustion doctrine need to be taken into account in determining the price for licenses and negotiating contract terms contemplating future sales or transfers. Similarly, first tier purchasers of licensed products need to give careful consideration to their potential liability to both intellectual property owners and downstream purchasers when negotiating contracts.

© 2008, Ward and Smith, P.A.

Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. E. Bradley Evans concentrates his practice in the representation of businesses and business persons in contract, business structure, and intellectual property disputes and litigation. Comments or questions may be sent to ebe@wardandsmith.com

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.