Supreme Court’s Lexmark Decision Expands Scope of Patent Exhaustion Defense

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From Fenwick & West LP:

For the fifth time this session, and following fast on the heels of its landmark decision in TC Heartland v. Kraft Foods earlier in May, the Supreme Court again reversed the Federal Circuit. The case, Impression Products, Inc. v. Lexmark International, Inc., significantly expands the scope of the patent exhaustion doctrine. The doctrine of patent exhaustion limits the rights that remain available to a patentee following the initial authorized sale of a patented item. In a 7-1 opinion issued on May 30, the Supreme Court reversed the Federal Circuit analysis concerning both domestic and foreign sales, overturning more than two decades of precedent at the lower courts. It held that “a patentee’s decision to sell a product exhausts all of its patent rights in that item, regardless of any restrictions the patentee purports to impose or the location of the sale.”

This case arises from a dispute between Lexmark, a manufacturer of printer cartridges, and resellers of its cartridges. Lexmark makes proprietary toner cartridges for printers, which it markets and sells both internationally and domestically. The Lexmark cartridges are sold either at full price, or at a discounted rate under its return program. Each return program cartridge carries a contractual single-use/no-resale obligation on the purchaser not to refill the cartridge with toner and reuse it. Other companies known as “re-manufacturers” acquire empty Lexmark cartridges (including ones sold under the return program) from purchasers in the United States and abroad, refill them with toner, and then resell them at lower prices.

Lexmark brought a patent infringement suit against several of these resellers. The litigation proceeded until only a single count of infringement remained against a single defendant, Impression Products. Impression Products did not contest the enforceability of Lexmark’s patents, or that the patents covered the cartridges that Impression Products imported and sold. Rather, Impression Products contested liability based solely on the defense of patent exhaustion and moved to dismiss Lexmark’s claim of infringement with respect to both cartridges sold domestically and those sold abroad.

With respect to cartridges that Lexmark sold domestically, the district court found that the doctrine of patent exhaustion barred Lexmark’s claims, even for cartridges subject to the post-sale use restrictions of Lexmark’s return program.

. . . .

Sitting en banc, the Federal Circuit ruled in favor of Lexmark on both the domestic and international exhaustion issues, holding that the neither Quanta nor Kirtsaeng overruled the limits on patent exhaustion under prior Federal Circuit case law.

. . . .

The Lexmark Court first considered the question of whether a patentee that sells a patented article domestically subject to express restrictions on a purchaser’s right to reuse or resell the product may then enforce those restrictions by bringing a lawsuit for patent infringement. In examining this question, the Lexmark Court drew heavily from its prior patent exhaustion decisions in Quanta and United States v. Univis Lens Co., 316 U. S. 241 (1942). These cases uniformly held that the first authorized sale in the U.S. of a material object terminates patent rights associated with that object and leaves a patentee without the ability, under patent law, to control the use or disposition of the product after the initial sale. These cases, however, left open the possibility that a patentee may still be able to place contractual restrictions on the use of the items it sold.

With Lexmark, the Supreme Court slammed that door shut. Indeed, all eight Justices agreed that—under the patent exhaustion doctrine—Lexmark’s sale of the cartridges extinguished the asserted patent rights, notwithstanding the contractual restrictions on reuse Lexmark attempted to place on the articles prior to sale. The Court based its decision not only on its prior patent exhaustion cases, but also on its copyright ruling in Kirtsaeng, which addressed the first sale doctrine codified at Section 109(a) of the Copyright Act. It explained its view that: “This well-established exhaustion rule marks the point where patent rights yield to the common law principle against restraints on alienation.”

. . . .

The Court noted that, while “[i]t is true that a patented method may not be sold in the same way as an article or device, [m]ethods nonetheless may be ‘embodied’ in a product, the sale of which exhausts patent rights.” Quanta also held that the patent exhaustion doctrine applied if the item sold is only a component of a device but “the incomplete article substantially embodies the patent because the only step necessary to practice the patent is the application of common processes or the addition of standard parts.” In other words, if an item “embodies essential features of the patented invention,” including method claims, and “their only reasonable and intended use was to practice the patent,” the sale of the item will exhaust the claim.

The Lexmark decision does nothing to disturb the Quanta framework. Accordingly, under the combination of Lexmark and Quanta, patent exhaustion applies where critical components of a claimed apparatus or method are sold by the patentee either domestically or internationally.

. . . .

The Lexmark Court suggested two situations where patent exhaustion may not apply.

First, because the doctrine depends on an initial sale, it may not apply where a patentee distributes a patented article pursuant to license, as opposed to in an outright sale. As the Court noted, “[a] patentee can impose restrictions on licensees because a license does not implicate the same concerns about restraints on alienation as a sale.” After all, “a license is not about passing title to a product, it is about changing the contours of the patentee’s monopoly.” By contrast, “[p]atent exhaustion 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.” It is, of course, common to distribute software, firmware, and other technology via license rather than sale, and thus patent exhaustion may be inapplicable for such distributions.

Second, patent exhaustion may also not apply where the unauthorized sale of a patented article occurs.

Link to the rest at Fenwick & West LP and thanks to Colleen for reminding me to post on this topic.

Colleen wondered if the Lexmark decision might have an impact on ebooks and the first sale doctrine that permits the resale of printed books by the purchasers thereof without restriction.

PG could hold forth on this topic at great length, but, in a reversal of his usual practice, he will restrain himself on this occasion.

The Lexmark decision is of interest to traditionally-published authors because it clearly distinguishes between the rights of the patent holder if a product embodying the patented apparatus is sold or if it is licensed.

If the product is sold, the patent is exhausted and the patent owner has no further rights to prevent anybody from doing almost anything with the product, including refill it. If the product is licensed, but not sold the patent holder may be able to control what happens to the product later on.

A US Circuit Court of Appeals has held that there is a distinction between licensing and sales under copyright law. PG has previously posted about this decision, FBT Productions LLC v. Aftermath Records, 621 F.3d 958 (9th Circ. 2010).

The FBT case involved the rapper, Eminem. For iTunes downloads, Eminem’s publisher was paying the same royalties as would have been due upon the sale of CD versions of the songs. Eminem contended that the relationship between the publisher and iTunes was a license of a subsidiary right, for which a much higher royalty was due under the singer’s publishing contract.

Ultimately, the court held that downloaded songs were licensed, not sold. Elements of the court’s decision were that only a single master copy of the song was provided to iTunes and Apple then made copies for downloading by the customer as opposed to Apple selling a separate CD to each purchaser.

The impact on authors comes with ebooks.

The Terms of Use for ebooks on the websites of Amazon, Barnes & Noble, Kobo, etc., say that ebooks are licensed to the purchaser, not sold to the purchaser.

For a long time prior to the Eminem case and, unaccountably, after the Eminem case, a great many publishers provided boilerplate royalty provisions that paid a percentage of the net income from each ebook sold by the publisher. Typically, this percentage is 25%. Quite often in a separate subsidiary rights section of the contract, a much higher percentage royalty is paid for the licensing of the author’s books.

The Lexmark case addresses a point of great concern to publishers – pirated copies of ebooks.

If a court were to apply the Lexmark reasoning to copyrights, the first sale of an ebook would exhaust all of the rights the publishers hold via their contracts with authors and ebooks could be freely resold on the used books market just like printed books are. If ebooks are licensed, resale of ebooks can be restricted. But higher royalty rates would seem to apply.

Finally, a bit of background – The Federal Circuit is an appeals court that only handles appeals from decisions of US District Courts on patents (plus a bunch of even more obscure items), regardless of the location of the original action.

US Circuit Courts of Appeal handle appeals of decisions within a particular geographical area, e.g. the Third Circuit Court of Appeals handles appeals of cases tried in Pennsylvania, New Jersey, Delaware, and the Virgin Islands.

Sometimes the various circuit courts of appeal issue conflicting decisions. That requires the US Supreme Court to straighten out the conflicts.

The theory behind the establishment of the Federal Circuit is that patent law is its own weird little area of the law, sometimes with a lot of technology and math thrown in, and that judges who specialize in hearing cases of that sort will usually be able to handle those appeals more efficiently.

As with the Circuit Courts of Appeal, decisions of the Federal Circuit can be appealed to the Supreme Court. The Supreme Court declines to hear most appeals from any of the lower appellate courts, however.

Lately, the Federal Circuit has gone off on a few frolics of its own and the Supreme Court has accepted more appeals in order to straight the law out.