The Exhaustion Doctrine and Related Antitrust Issues

By William Rowland,[Anti-Monopoly]

Shareholder at Buchanan Ingersoll & Rooney PC and former chairman of the Intellectual Property Law Section of the American Bar Association
  
  According to the Exhaustion Doctrine, when a patented item is lawfully made and sold, the patent owner exhausts its rights in the product.  However, exhaustion is triggered only if the sale is made by or authorized by the patent owner.
  
  One of the leading cases on this issue is the recent U.S. Supreme Court decision in Quanta Computer, Inc. v. LG Electronics, Inc., 553 U.S. ____; 128 S.Ct. 2109; 86 USPQ2d 1673 (2008).
  
  Background of Quanta v. LG:
  
  There were three parties involved in the Quanta Computer case. The first party was LG Electronics, who owned and licensed several patents.  The second party was Intel, a licensee of the LG patents, who made chips and chipsets that were to be used in equipment that was covered by the LG patents.  The third party was Quanta Computer, Inc., who purchased the chips from Intel and sold finished products in the United States.
  
  There were at least two relevant agreements between LG and Intel.  The first agreement, referred to as the “License Agreement”, permitted Intel to make, use, sell, offer to sell, or import its own products practicing the LG patents.  However, the license indicated that products made by a third party were not licensed under the LG patents if the products were made using components that were acquired from anyone other than Intel or LG.  Specifically,  the License Agreement stated that no license is granted to any third party for a combination by the third party of the Licensed Products of either party with items, components, or the like, acquired from sources other than a party. It is important to note that, as construed by the U.S. Supreme Court, nothing in the License Agreement specifically restricted Intel’s right to sell its microprocessors and chipsets to purchasers who intended to combine them with non-Intel parts.  In fact, the Court found that the agreement broadly permitted Intel to “make, use, or [sell]” products free of LG’s patent claims.  Thus, nothing in the License Agreement prohibited Intel from doing anything.  The License Agreement merely stated that third parties were not licensed under certain circumstances.
  
  A second agreement between LG and Intel, referred to as the “Master Agreement,” required Intel to give written notice to its own customers informing them that the license does not extend, expressly or by implication, to any product made by combining an Intel product with any product other than an Intel or LG product.  As with the License Agreement, as construed by the U.S. Supreme Court, the Master Agreement did not prohibit Intel from doing anything.  It merely required Intel to give notice.
  
  Quanta Computer, Inc. purchased chips and chipsets from Intel and combined them with non-Intel memory and buses to manufacture computers that practiced the technology claimed in the LG patents.  LG filed a complaint against Quanta asserting that the products made by combining the Intel products with non-Intel memory and buses constituted an infringement of the LG patents.
  
  In response to the complaint by LG, Quanta argued that Intel’s sales of the chips exhausted LG’s rights in the patents, and therefore LG could not sue Quanta for patent infringement.
  
  In the lawsuit between LG and Quanta, the trial court held that patent exhaustion applied only to apparatus or composition of matter claims, and did not apply to method claims.  Accordingly, the court found that LG had not exhausted the method claims in its patents.  The decision of the trial court was appealed to the U.S. Court of Appeals for the Federal Circuit.  The Court of Appeals for the Federal Circuit agreed with the trial court that the doctrine of patent exhaustion did not apply to method claims.  The Court of Appeals also concluded that the exhaustion doctrine did not apply in this particular case because LG did not license Intel to sell the Intel products to Quanta for use in combination with non-Intel products.
  
  Supreme Court Decision in Quanta v. LG:
  
  The decision of the Court of Appeals for the Federal Circuit was appealed to the U.S. Supreme Court, and in 2008, the U.S. Supreme Court reversed the lower courts.  There were three issues before the U.S. Supreme Court.
  
  1.   Does the Exhaustion Doctrine apply to method claims?
   
  2.   Can the sale of an article that, by itself, does not include each of the elements of a patent claim exhaust a patent owner’s rights in the product?
  
  3.   What constitutes an authorized sale for purposes of the Exhaustion Doctrine?
   1.  Exhaustion of Method Claims
  
  The U.S. Supreme Court held that claimed methods may be “embodied” in a product, and if method claims are embodied in a product, an authorized sale of the product will exhaust the patent owner’s rights in the method claims.  The court found that eliminating the Exhaustion Doctrine for method claims would seriously undermine the doctrine.
  
  2. Sales of an Incomplete Article
  
  If an article sold does not include all of the elements of a patent claim, the article is considered incomplete with respect to that patent claim.  The U.S. Supreme Court found that sales of an incomplete article do not necessarily exhaust patent rights in that article.  However, if the incomplete article “embodies” the essential features of the patented invention, then exhaustion is triggered by the sale of the article if its only reasonable and intended use was to practice the patent.
 
  The court found in the Quanta case that the only apparent object of Intel’s sales to Quanta was to permit Quanta to incorporate the Intel products into computers that would practice the patents.  The court also found that the Intel products constituted a material part of the patented invention and all but completely practiced the patent.  In other words, everything inventive about each patent was embodied in the Intel products.  Based on those findings, the court concluded that the Intel products embodied the essential features of the LG patents because they carry out all the inventive processes when combined, according to their design, with standard components.  Making a product that substantially embodies a patent is, for exhaustion purposes, no different from making the patented article itself.
  
  Accordingly, the U.S. Supreme Court concluded that even though Intel’s sales did not include all elements of the patent claims, the sold products were sufficiently complete to exhaust LG’s patent rights - provided the sales were authorized by LG.
  
  3. What Constitutes an Authorized Sale
  
  The U.S. Supreme Court clearly concluded that Intel’s sales to Quanta were authorized by the LG - Intel License Agreement.  However, the basis for this conclusion is not clear.
  
  Specifically, the U.S. Supreme Court found that the LG-Intel contract did not prohibit Intel from selling to third parties, such as Quanta:
  
  Nothing in the License Agreement restricts Intel’s right to sell its microprocessors and chipsets to purchasers who intend to combine them with non-Intel parts.  It broadly permits Intel to “‘make, use [or] sell’” products free of LGE’s patent claims.
  
  The court found that Intel’s authority to sell its products embodying the LG patents was not conditioned on the notice required by the Master Agreement, or on Quanta’s decision to abide by LG’s directions in that notice.  (“Hence, Intel’s authority to sell its products embodying the LGE patents was not conditioned on the notice or on Quanta’s decision to abide by LGE’s directions in that notice.” Id. at 2122).
  
  Accordingly, the court concluded that although no license was given to Quanta to resell the chips, the sale of the chips by Intel to Quanta was authorized by LG:
  
  The license agreement authorized Intel to sell products that practiced the LGE Patents.  No conditions limited Intel’s authority to sell products substantially embodying the patents.

  Because Intel was authorized to sell its products to Quanta, the doctrine of patent exhaustion prevents LGE from further asserting its patent rights with respect to the patents substantially embodied by those products.
  
  The License Agreements Were Faulty:
  
  One possible explanation for the Court’s conclusion that the sales were authorized is that the agreements between LG and Intel were faulty in that they did not accomplish what LG clearly wanted, i.e., to limit the license on the patents to only products that were made using Intel or LG components and thus prevent an Intel customer from combining the Intel chips and chipsets with non-Intel parts and selling products that embody the LG patents.  Under this theory, had the LG - Intel agreements been drafted differently, the Court may have found that Intel’s sales to Quanta were not authorized and that LG’s rights were not exhausted by the sales.
  
  Or - Limits on Post Sale Restrictions?
  
  On the other hand, some have argued that the Supreme Court’s opinion in Quanta stands for the proposition that the restrictions in the LG - Intel agreements were irrelevant.  In other words, it has been argued that Quanta stands for the proposition that an authorized sale of a patented item, even those made with certain restrictions, exhausts the patent rights to the sold products.  See, for example, Broadcom Corporation’s Opposition To Qualcomm Incorporated’s Motion To Dismiss, filed on February 9, 2009 in Broadcom Corp. v. Qualcomm Inc., case no. 08-CV-01829, S. D. Cal. (“…any post-sale restrictions on use imposed by the patentee are unenforceable through patent infringement actions.” at 7 - 8).
  
  To support this position, Broadcom quotes two earlier U.S. Supreme Court decisions:
  
  …one who has sold an uncompleted article which, because it embodies essential features of his patented invention, is within the protection of his patent, and has destined the article to be finished by the purchaser in conformity to the patent, has sold his invention so far as it is or may be embodied in that particular article.
  
  United States v. Univis Lens Co., 316 U.S. 241, 250 - 251 (1942), and
  
  It is well settled, as already said, that where a patentee makes the patented article, and sells it, he can exercise no future control over what the purchaser may wish to do with the article after his purchase.  It has passed beyond the scope of the patentees rights.
  
  United States v. Gen. Elec. Co., 272 U.S. 476, 489 (1926).
  
  However, Broadcom’s reliance on the two U.S. Supreme Court’s decisions is misleading.  For example, both the Univis case and the General Electric cases were antitrust cases, not patent infringement actions.  There is no question that the Univis opinion includes broad language stating that the sale of an article exhausts a patent owner’s monopoly in the article “and the patentee may not thereafter, by virtue of his patent, control the use or disposition of the article.” 316 U.S. at 250.  However, the issue decided by the Court in Univis was whether the patent monopoly granted the licensor exempted the licensing scheme from the “operation of the Sherman Act.”  316 U.S. at 243.  The Univis court was not deciding whether certain sales were authorized, it was deciding whether post-sale pricing restrictions were subject to scrutiny under the antitrust laws.  The Univis opinion did not adversely address previous U.S. Supreme Court opinions in which use restrictions were imposed on the sale of patented articles.  See, e.g., Providence Rubber Co. v. Goodyear, 76 U.S. (9 Wall.) 788 (1870) (a restricted license to use the patented technology only for India-rubber cloth); Adams v. Burke, 84 U.S. (17 Wall.) 453 (1874) (a geographic limit in a license); American Cotton-Tie Co. v. Simmons, 106 U.S. 89 (1882) (a single use restriction on the sale of patented ties); and General Talking Pictures Corp. v. Western Electric Co., 304 U.S. 175, 58 S.Ct. 849, 82 L.Ed. 1273 (1938) (a restriction on the sale of amplifiers for home use only).
  
  In the Quanta opinion, the Univis case is discussed in two sections:  (1) whether method claims can be exhausted and (2) whether the sale of an incomplete article can exhaust a patent owner’s rights.  It is significant that, in the portion of the Quanta opinion discussing whether Intel’s sales were authorized, there is no discussion of Univis or General Electric.
  
  Furthermore, in Quanta, the Court speaks approvingly of prior decisions holding that post-sale restrictions could be made, as long as the restrictions did not constitute antitrust violations.  For example, Quanta refers to General Talking Pictures Corp., id., wherein sales of patented amplifiers were made with the restriction that the amplifiers could only be resold for private and home use.  The Court in General Talking Pictures Corp. found that sales of the amplifiers did not exhaust the patent owner’s rights to sue for infringement when the amplifiers were resold for commercial use.  The Quanta decision goes on to state:
  
  LGE overlooks important aspects of the structure of the Intel - LGE transaction.  Nothing in the License Agreement restricts Intel’s right to sell its microprocessors and chipsets to purchasers who intend to combine them with non-Intel parts.  It broadly permits Intel to “‘make, use, [or] sell’” products free of LGE’s patent claims.
  
  Accordingly, contrary to Broadcom’s assertions, Quanta does not stand for the proposition that any post-sale restrictions on use imposed by the patentee are unenforceable through patent infringement actions.  Instead, it appears that the Quanta Court simply did not find any such restrictions in the LG - Intel agreements.
  
  Mallinckrodt, Inc. v. MediPart, Inc.:
  
  Another problem with Broadcom’s theory is that it is clearly inconsistent with Mallinckrodt, Inc. v. MediPart, Inc., 976 F.2d 700 (Fed. Cir. 1992).  In the Mallinckrodt case, the patent owner sold patented medical devices with a clear “single use” restriction.  The purchaser of the medical devices sold the devices to a third party to refurbish and reuse the devices.  The patent owner sued the refurbishing company for patent infringement, and the Court found that since the sales to the original purchasers of the medical device were authorized for only a single use, the sale was not an unrestricted authorized sale, and therefore patent exhaustion did not apply.  In Mallinckrodt, the court found liability for patent infringement.
  
  In the Mallinckrodt case, the Court held that the patentee had the right to impose certain restrictions on the use of the product, provided that the restrictions did not violate some other law or policy, such as patent misuse or antitrust law.  If, as alleged by Broadcom, the Supreme Court intended to overrule Mallinckrodt with the Quanta opinion, it is likely that the Quanta opinion would have addressed this issue.  It is significant that the Supreme Court Quanta opinion never mentions Mallinckrodt, even though the briefs in the Quanta case clearly referred to the Mallinckrodt decision.  See, e.g., the Brief for the United States as Amicus Curiae in the Quanta case:
  
  The test adopted by the Federal Circuit in Mallinckrodt thus reflects a fundamental misunderstanding of the role and scope of the patent-exhaustion doctrine.
  
  Quanta Computer, Inc. v. LG Elec., Inc., Brief for the United States as Amicus Curiae, at 23.
  
  Accordingly, in spite of some commentary to the contrary, the better view seems to be that the Supreme Court in Quanta found that Intel’s sales were authorized because of a flaw in the LG - Intel agreements.  It does not stand for the principal that any post-sale restrictions on use imposed by the patentee are unenforceable through patent infringement actions.  However, this point is far from clear based on the language in the Quanta opinion.
  
  However, even under Mallinckrodt, there are limits as to the types of restrictions a patentee can place on the sale of its products.  For example, such restrictions cannot violate the law or policies such as patent misuse or antitrust law.  Some restrictions are per se antitrust violations.  (“These cases established that price-fixing and tying restrictions accompanying the sale of patented goods were per se illegal.”  Mallinckrodt 976 F.2d at 704.)
  
  A restriction is considered to be per se illegal if it violates the antitrust statutes regardless of the circumstances.  In other words, the restriction is per se illegal regardless of any good motivation between the parties, any beneficial results to customers, any decreased prices, or any other market effects.  One example of a per se violation is horizontal price fixing.  Horizontal price fixing includes agreements among competitors to fix prices.
   
  If the restriction is not a per se violation, but does have an anti-competitive effect, then the Rule of Reason is used to determine the legality of the restriction.  Under the Rule of Reason, a factual determination is made to determine whether the overall effect of the restriction tends to restrain competition unlawfully in an appropriately defined market.
  
  Another tool for enforcing post-sale restrictions in a patented product is mentioned in footnote 7 of the Quanta decision.  In that footnote, the Court states that “…we express no opinion on whether contract damages might be available even though exhaustion operates to eliminate patent damages.”  S.Ct. at 2122.  Thus, a situation may exist where a patentee has exhausted its patent rights in a product through a sale of the product, but may still retain some control through the use of contracts.  Of course, enforcement of a contract would require some relationship between the patent owner and the defendant being sued.  In contrast, if the patent owner’s rights in the patent were not exhausted by the sale, no such privity would be required in a patent infringement action.
  
  The debate concerning the ability of patent owners to maintain control over products after a first sale or transfer of the products, particularly for purposes of maximizing royalty income, continues in the courts today.  One such battle is the aforementioned dispute between wireless rivals Qualcomm Inc. and Broadcom Corp.
  
  Qualcomm uses a Subscriber Unit License Agreement (SULA) which licenses manufacturers to make, use, and sell handsets.  Qualcomm also uses an ASIC Patent License Agreement (APLS) which licenses chipmakers to make and sell ASICs only to handset makers that are “authorized purchasers”, i.e., handset manufacturers that have SULA agreements with Qualcomm.  The APLS does not authorize a chip manufacturer to use the chips, other than for testing purposes.
  
  Thus, Qualcomm’s APLS agreements have two significant limitations.  First, they only allow chipmakers to sell ASICs to “authorized purchasers”, i.e., handset manufacturers that have SULA agreements with Qualcomm.  Second, the APLS does not authorize a chip manufacturer to use the chips, other than for testing purposes.  Under Qualcomm’s licensing system, Qualcomm obtains a royalty for the manufacture of the basic chips used in the handsets, as well as a second royalty from the manufacture of the completed handset that uses the basic chips.
  
  On October 7, 2008, Broadcom filed a complaint in U.S. District Court for the Southern District of California alleging that Qualcomm’s licensing scheme constitutes patent misuse and is prohibited by the doctrine of patent exhaustion.  Broadcom’s complaint alleges, among other things, that Qualcomm’s patents are “exhausted” and misused.  In response, Qualcomm filed a motion to dismiss Broadcom’s complaint.
  
  In view of the licensing agreements used by Qualcomm, this case can be distinguished from the Quanta case.  However, Broadcom takes some very broad, sweeping positions, essentially arguing that the U.S. Supreme Court Quanta decision held that any authorized sale, regardless of restrictions imposed thereon, triggers the Exhaustion Doctrine.
  
  In the defense of the lawsuit by Broadcom, Qualcomm has not taken on this issue directly.  Qualcomm has instead challenged Broadcom’s complaint on procedural flaws, alleging that Broadcom does not have standing and that the issue is not ripe for declaratory judgment.  On March 12, 2009, the Court granted Qualcomm’s motion to dismiss.  Therefore, it may be some time before there are any meaningful judicial declarations on the true merits of this exhaustion dispute between Broadcom and Qualcomm.
  
  Conclusion:
  
  Thus, under the Supreme Court decision in Quanta, for the Exhaustion Doctrine to apply:
  
  1. the sale must be authorized by the patent owner;
  
  2. the products sold must embody the essential features of the patented invention; and
  
  3. method claims can be exhausted if the claimed method is embodied in the sold product.
  
  And, in determining whether or not exhaustion applies, there are several issues to consider:
  
  1. do the sold products have a reasonable, non-infringing use?
  
  2. do the sold products substantially embody the patented technology?
  
  3. are the sales of the products authorized by the patent owner? 
  
  Although Quanta provides some guidance for making such determinations, with today’s technology becoming ever more complex, such issues may not be easy to determine.  Therefore, as a result of the Quanta opinion, it is important to clarify in a sales or license agreement exactly what is and what is not “authorized” by the sale or license.  The LG - Intel contracts presumably did not clearly state what was and was not an authorized sale by Intel.
  
  It is also important to consider including additional remedies in such sales or license agreements, such as breach of contract remedies.  For example, even if a sale exhausts the patent rights in a product, the patent owner may have enforceable rights in sales or licensing agreements associated with the sales.

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