Patent Exhaustion: Supreme Court Expands Patent-Limiting Doctrine

The U.S. Supreme Court at the end of the past term handed down a decision, Impression Products, Inc. v. Lexmark International, Inc., that greatly expanded the doctrine of patent exhaustion.[1] This equitable doctrine prevents a patent holder from restricting further sales or use of a patented invention once the patentee has received the benefits of her patent from a first sale. In doing so, the Court upset the settled expectations of many patent holders and their licensees. Paradoxically, the decision is not inconsistent with the Court’s recent pronouncements in other patent cases and other areas of intellectual property.[2] All of these decisions are also consistent with the Court’s recent trend of limiting patent rights to the greatest extent possible as patent cases continue to come before it.

Background and the Opinion

In its Lexmark opinion, the Court reversed the Federal Circuit regarding the metes and bounds of the patent exhaustion doctrine. Simply stated, the Court ruled that the doctrine precludes a patentee from using the patent laws to enforce any agreement that restricted a purchaser’s post-sale ownership rights in a patented article. The decision also reversed Federal Circuit precedent that permitted patentees to limit the scope of rights transferred to purchasers upon sale of a patented article, provided that such restrictions were “clearly worded.”[3] This portion of the decision was not entirely surprising, being consistent with earlier cases.[4] What was unexpected, however, was the Court’s further decision that exhaustion arose even as a consequence of sales of patented products sold abroad. This decision overturned the Federal Circuit’s Jazz Photo Corp. v. International Trade Commission decision, which had held that such products were outside the reach of exhausting U.S. patent rights.[5]

The case in Lexmark arose over the resale of laser printer toner cartridges, sold by Lexmark both in the U.S. and abroad. These cartridges were sold at a discount under an agreement that prohibited the buyer from selling the cartridges to any third party for reloading with new toner. Each cartridge contained a microchip that prevented third-party reloading; but technology developed in ways that the chip could be overridden. Petitioner/accused infringer Impression Products reloaded and sold Lexmark cartridges obtained from discount purchasers, both foreign and domestic. The district court dismissed Lexmark’s infringement suit as to U.S. sales, but permitted pursuit of a patent infringement remedy for foreign sales, the Federal Circuit affirmed as to foreign sales but permitted Lexmark’s infringement case to proceed for U.S. sales as well.

The Federal Circuit, relying on its (now-overruled) decision in Mallinckrodt, Inc. v. Medipart, Inc., held that the patent right included the right to impose “clearly communicated” post-sale restrictions that could be enforced by an infringement suit.[6] The Court’s basis for this opinion was that the law defines infringement as “making, using, selling, offering to sell, or importing” a patented article “without authority,” and thus post-sale restrictions would comprise infringement because they expressly denied the purchaser the requisite authority for unrestricted use.[7] The Federal Circuit opined that the exhaustion principle presumptively prevented such restrictions but that presumption could be expressly rebutted by such post-sale restrictions.

As for sales made abroad, the Federal Circuit relied on its (now also overruled) decision in Jazz Photo Corp. v. International Trade Commission, where foreign sales did not preclude an infringement suit for unauthorized importation and sale of a patented article.[8] This decision was based on the fact that a patentee did not reap the benefits of patent protection for sales made abroad, due to the lack of extraterritorial effect of a U.S. patent. The patentee does not receive a patent premium for a U.S. patent when an infringing article was sold abroad, and under these circumstances the Federal Circuit believed exhaustion was not justified.

Impression Products presented the Supreme Court with two questions: (1) Can a patentee impose an express restriction on use or reuse of a patented product sold in the U.S. that is enforceable under the patent laws?; and (2) Does sale of a patented article abroad exhaust the patentee’s right to restrict importation of a product sold abroad? The Supreme Court’s decision that the answer to both questions is “No” was based on its application of the common law principle against restraints on alienating property. Specifically, the Court reiterated that the patent exhaustion doctrine is grounded in this “ancient” principle and that patent law does not abrogate this proscription.[9] The Court’s opinion as to U.S. sales was unanimous, in an opinion colorfully written with regard to the facts by Chief Justice Roberts. Justice Ginsberg dissented with regard to foreign sales, which she believed should not exhaust U.S. patent rights. Justice Gorsuch did not participate in the decision.

For resale of cartridges purchased in the U.S., the Court struck down any and all post-sale restrictions, holding that all patent rights were exhausted upon first sale. The basis for this decision was grounded expressly on the extent of protection provided by U.S. patent law, the Court recognizing that U.S. contract law might provide a cause of action (albeit limited by privity and other contract law restrictions). According to the Court’s opinion, patent exhaustion and its application has been consistent in U.S. law for over 160 years.[10] The Court characterized the function of exhaustion to operate “automatically”; once a patentee sells a patented article that article becomes “private, individual property” of the purchaser subject to no further rights by the patentee.[11] U.S. patent law rights conferred on a patentee are limited to the ability to set prices and negotiate with purchasers over terms of sales, but once the sale is made the patentee does not have the right, under patent law, to “control the use or disposition” of the product according to the Court.[12] This principle is consistent with the Court’s recent decision in Quanta Computer, Inc. v. LG Electronics, Inc.; indeed, the opinion states that this earlier decision should have removed “any lingering doubt that patent exhaustion applies even when a sale is subject to an express, otherwise lawful restriction.”[13]

The Lexmark opinion also provides, as an illustration of the “annoyance and inconvenience” to the public that would result from the Court deciding otherwise, what could be expected to occur in an auto repair shop, where the component parts (should they be subject to post-sale restrictions) could leave a mechanic open to patent infringement liability for servicing a privately owned vehicle. According to the Court, “[the] smooth flow of commerce would sputter if companies that make the thousands of parts that go into a vehicle could keep their patent rights after the first sale,” a conclusion bolstered by amici briefs that used smartphones and other articles of manufacture constituting multiple patented components to make (quite persuasively, it seems) this very point.[14]

The opinion succinctly states the scope of the exhaustion doctrine: “Patent exhaustion is uniform and automatic. Once a patentee decides to sell—whether on its own or through a licensee—that sale exhausts its patent rights, regardless of any post-sale restrictions the patentee pur­ports to impose, either directly or through a license.”[15] As for Lexmark, the Court stated that its remedy, if any, must be found in contract, but recognized that the party who would have infringement liability (e.g., remanufacturers like Impression Products) are not in privity with the patentee and thus contract law under these circumstances does not provide an easily applied remedy.[16] 

With regard to sales abroad, the Court again cited Kirtsaeng and found the same grounding for its decision in the unlawfulness of restraints on the alienation of chattels.[17] Because this common law principle applies without regard to where the post-sale activity takes place, the distinction Lexmark (and Justice Ginsberg in dissent) made regarding foreign versus domestic sales disappears for the Court majority. The Court found the application of these principles in the patent context “just as straightforward” as in copyright, and moreover, saw no “theoretical or practical” sense in differentiating between patent and copyright on exhaustion, citing the “many everyday products . . . subject to both patent and copyright protections.”[18] The Court was unmoved by Lexmark’s argument that, without patent protection a foreign sale would not command the patent premium on price, noting: “[T]he Patent Act does not guarantee a particu­lar price, much less the price from selling to American consumers. Instead, the right to exclude just ensures that the patentee receives one reward—of whatever amount the patentee deems to be ‘satisfactory compensation.’”[19]

The Path Forward

The Court’s decision in Lexmark (as in the Quanta and Kirtsaeng decisions before it) has important ramifications for patent claims, more so for some technologies than others. For Lexmark itself, future sales may be made that offer a rebate for returned printer cartridges, rather than a discount for agreeing not to sell to third-party resellers. As the patentee, there may be room in the economic structure of its activities for the incentive provided by the rebate to overcome the price discount resellers can offer, and for the resulting reduction in competing refilled toners justifying the discount.[20] For most commodities, such a scheme may well limit the extent to which the Court’s decision interferes with their settled manner of licensing patented products.

For other technologies it may be necessary to adapt patent strategies in order to fully avoid the deleterious effects of this decision. In biotechnology, for example, there are two immediately evident examples: (1) cases where a patentee limits post-sale rights by a so-called “label license” for uses for a patented article; and (2) cases where a patented article has the biological property of replication, where the license precludes use of replicates of the article after purchase.

An example of the first type of situation would be the limits placed on the practice of the polymerase chain reaction (PCR), based on patents to both the amplification method and the thermostable polymerase. The restrictions in such label licenses were typically of two types. First, licenses to the method were granted only upon purchase of the patented polymerase and use of an “authorized” thermocycler instrument. Second, the method (and for that matter, the polymerase) was not licensed for diagnostic uses, only for scientific research. Under the patent exhaustion doctrine set forth in the Lexmark opinion, however, it is likely that neither of these restrictions would be enforceable. Specifically, although the polymerase has other uses that would not infringe the claims of the PCR method patent, it is likely that sale of the thermostable polymerase would exhaust the method claims as well, since the thermostable characteristic of the polymerase embodies essential features of the claimed invention. This is even more likely regarding the diagnostic use prohibition, since it represents the kind of restriction the Court prohibited in Adams v. Burke.[21]

The second type of post-sale restriction important to biotechnology are those that limit use of a patented article that is capable of self-replication; the most (in)famous cases of this type were the Monsanto herbicide-resistant seed cases, where the “label license” prohibited replanting seed produced using the recombinant seed purchased from the company (albeit this situation was one where there was an express license between Monsanto and purchasing farmers and the third party aspects of the Lexmark case were not present). For example, Monsanto won a Supreme Court challenge to its use of patent infringement lawsuits to enforce its right to restrict resale of patented soybeans, in Bowman v. Monsanto several years ago, involving a farmer who reused seed contrary to Monsanto’s restrictions on reuse.[22] The restrictions permitted under those circumstances may be limited to the unique nature of that invention, however, wherein producing more soybeans was the intended (and perhaps only) use of the invention. Furthermore, Justice Kagen’s opinion in that case was qualified, wherein she noted that the Court’s holding was “limited—addressing the situation before us, rather than every one involving a self-­replicating product” and adding that:

We recognize that such inventions are becoming ever more prevalent, complex, and diverse. In another case, the article’s self-replication might occur outside the purchaser’s control. Or it might be a necessary but incidental step in using the item for another purpose. . . . We need not address here whether or how the doctrine of patent exhaustion would apply in such circumstances.[23]

Either way, the Court’s decision in Lexmark requires creativity on the part of patentees and their licensees in crafting agreements that retain the ability to use patent infringement litigation to enforce property rights post-sale. The ancient patent exhaustion principle presented therein may be countered by the equally ancient principle that parties may contract in any manner not prohibited by law. Application of such principles can be expected to be extremely fact- and circumstance-dependent, however. Further examples could include either making updates or authorized repairs only available to original consumers or offering extended warranties for “factory authorized” replacement parts. By tying valuable benefits as an incentive to deal with the patentee or her licensee, a patentee may be able to receive extended benefits post-sale by way of a consumer’s choice rather than a post-sale restriction.

Similarly, absent the ability to restrict foreign resale (particularly re-importation of goods sold abroad, analogous to the textbooks sold in the Kirtsaeng decision) patentees may be forced to alter their global sales strategies. This is particularly true when there are large differences in price for a patented article sold abroad compared with the price paid by the U.S. consumer. Possible strategies for reducing the economic effect of unfettered foreign sales include tailoring the amount of such sales to each market, so that there is not a great enough surplus for significant American resale to occur, or adjusting the price differential to minimize the economic advantage of re-importation while not severely reducing foreign sales or providing incentives for generic competition. The greatest risk for re-importation seems to be in the branded drug market, which is protected (for now) by U.S. laws preventing re-importation of these drugs. Increasing pressures on drug costs, however, raise as a distinct possibility some lessening or elimination of these protections, and with them, further uncertain effects on U.S. and global drug pricing.

The Lexmark decision may also affect how inventions are protected by patenting (when such protection is possible). Patents on articles of manufacture for simple mechanical devices are the most analogous to Lexmark’s patents and are at the most risk as a result of this decision. As the complexities of an invention increase, however, there may be (under the right circumstances) avenues for patentees to parse out claims to methods, improvements, or other aspects that may provide independent grounds for restricting post-sales activities that would pass Supreme Court muster under the Lexmark decision.

Conclusion

What is abundantly clear is that the Supreme Court by its Lexmark decision has eviscerated completely the Federal Circuit’s interpretation of the effect of patent exhaustion on patent rights. In this, as in many other aspects of patent law, the Court has determined that its views are the correct (if not only) views upon which patentees and the public are entitled to rely. The wisdom of consistently rejecting the Federal Circuit’s “special expertise” on U.S. patent law (in this and so many other examples) under the Court’s current proclivities remains to be seen. But for patentees, for now, the Lexmark decision will require an entirely new approach to protecting patented items offered for sale anywhere on earth.

© 2017 McDonnell Boehnen Hulbert & Berghoff LLP

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