Editor’s Note: A. José Cortina is a member of the Intellectual Property Practice Group at Ward and Smith, P.A.
Last summer, E. Bradley Evans of our firm published an article for Local TechWire discussing the implications of the June 2008 U.S. Supreme Court decision in the case of Quanta Computer, Inc. v. LG Electronics, Inc. (“Quanta”) on the patent exhaustion doctrine. This article addresses the aspects of Quanta that may make it difficult for a patent holder to impose contractual restrictions that will prevent the application of the patent exhaustion doctrine to downstream purchasers and force those purchasers to obtain a license under such patents.
The Facts of Quanta
In Quanta, LG Electronics, Inc. (“LGE”) issued a license for certain LGE patents to Intel Corporation (“Intel”) that permitted Intel to make and sell Intel microprocessors and chipsets using the LGE patents (the “Intel products”). The LGE license specifically stated that no license was granted to Intel customers to combine the Intel products with components that were not manufactured by Intel. Under the terms of a separate Master Agreement between Intel and LGE, Intel was required to provide notice to its customers that the license for the Intel products sold to them did not extend to any product made by combining an Intel product with a non-Intel product. However, the terms of the Master Agreement also specifically stated that any breach of such Master Agreement would not affect the license agreement between Intel and LGE.
Intel sold Intel products in the ordinary course of business to various customers, including Quanta Computer, Inc. (“Quanta”), and provided such customers with the required written notice of the absence of a license for products using components that were not manufactured by Intel. Although Quanta bought the Intel products from Intel and then combined them with components other than those manufactured and sold by Intel, Quanta did not take a license under certain LGE patents covering combinations and methods resulting from the mixing of non-Intel components with its product. This resulted in Quanta being sued by LGE for patent infringement. In its defense, Quanta argued that it did not infringe the LGE patents because of the application of the patent exhaustion doctrine which provides that a patented item’s initial authorized sale terminates all patent rights to that item.
The Court’s Ruling
The license agreement between LGE and Intel addressed the patent exhaustion issue by providing only that “the parties agree that nothing herein shall… limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products.” As a result, LGE argued that the exhaustion doctrine did not apply to method claims contained in each of its patents. Quanta, however, argued that there was no reason to preclude method claims from the exhaustion doctrine, and pointed out that prior cases applied the exhaustion doctrine in cases involving method claims. The U.S. Supreme Court agreed with Quanta, and noted that eliminating the exhaustion doctrine from method claims would undermine the doctrine because patentees could void the doctrine simply by drafting their patent claims to describe a method rather than an apparatus.
The other issue considered by the Court was whether or not a product must fully embody a patent (e.g., meet all of the limitations of the claims) in order to trigger exhaustion if such product is sold. The Court ruled, under the facts of Quanta, that there was no such requirement because the Intel products involved constituted a material part of the patented invention and all but completely practiced the patent. Even though Intel sold an incomplete article/product to Quanta, the Court, ignoring the individual limitations of the patent claims, found that the products substantially embodied the LGE patents because the only thing necessary to practice the patents was the application of common processes or the addition of standard parts. The Court concluded that everything inventive about each LGE patent was embodied in the Intel products even if the products did not meet every limitation of the patent claims, and noted that such products could not carry out their intended functions unless they were attached to certain non-Intel products as described and claimed in the patents.
As an alternative to ignoring the specific limitations of the claims, the Court could have addressed the well-known doctrines of contributory improvement or inducement to infringe in the context of the contract language to reach its “exhaustion” result. The Court chose to ignore traditional infringement patent analysis and to focus instead on the loose “embodied the invention” standard to reach its result.
Even though LGE pointed out that its license agreement specifically disclaimed any license to third parties, the Court found such an argument irrelevant because Quanta had asserted its rights to practice the patents based, not on an implied license from Intel, but on patent exhaustion principles. In accordance with the Court’s ruling, exhaustion then turns only on Intel’s own license to sell products practicing the LGE patents. The Court further noted that the license agreement between LGE and Intel authorized Intel to sell products that practiced the LGE patents and did not limit Intel’s authority to sell products substantially embodying such patents. Since Intel was authorized to sell its products to Quanta, the doctrine of patent exhaustion prevented LGE from further asserting its patent rights with respect to the patents substantially embodied by those products.
In discussing the apparent lack of contract restrictions, it appears the Court was suggesting that more carefully drawn contract language with tighter restrictions may be effective to avoid patent exhaustion. However, such an approach may invite patent misuse claims if a party attempts contractually to achieve a result not covered by the claims of a patent.
Lessons Learned
What is the lesson in all of this? One answer is to take particular care in drafting any license agreement that purports to impose restrictions on customers of the licensee. A licensor should very carefully draft the nature of such a grant and the restrictions placed thereon, particularly in situations where the licensed products are components that have no use other than in a combination that would infringe the licensor’s patents. On the other hand, such restrictions should not extend beyond what the patent claims restrict. For example, a contractual obligation requiring the licensee to ensure its customer is licensed under the patents, and preventing the licensee from selling to non-licensed customers, may provide effective protection.
Even with such care, it may be that the nature of the products sold and how they are sold will make it impossible to avoid patent exhaustion given the Court’s analysis based on the product substantially embodying the invention. It is essential to have a sound knowledge and understanding of the facts, the technology, and the relevant patents. Perhaps the easiest path will be to avoid imposing license restrictions altogether and to impose a financially-tiered structure relative to licensees and non-licensees. For example, a first royalty amount may be set at a high level for sales to non-licensees, and a second lower royalty amount may be set for sales to licensed customers. However, such an arrangement needs to be crafted carefully to avoid running afoul of relevant antitrust and misuse laws.
Conclusion
Obviously, license drafters need to carefully and methodically structure transactions to take into account all of the factors discussed in the Quanta decision, as well as understand very clearly the potential pitfalls created by the Court’s opinion so as to avoid serious harm to a patent owner’s rights. Only time will tell if other, more notable questions and issues surrounding patent exhaustion may arise in light of Quanta.
© 2009, 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. A. José Cortina practices in the firm’s Intellectual Property Practice Group, where he concentrates his practice on patents, trademarks, copyrights, and related matters. Comments or questions may be sent to ajc@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.
