On February 12, 2016, in a 10-2 decision, the en banc Federal Circuit ruled on two major issues related to patent exhaustion, a doctrine allowing purchasers of goods embodying patented inventions in authorized sales to make certain uses, including resales, that would otherwise give rise to patent infringement. Lexmark Int’l, Inc. v. Impression Prods., Inc., No. 2014-1617 (Fed. Cir. Feb. 12, 2016) (en banc). The majority opinion held that, “when a patentee sells a patented article under otherwise-proper restrictions on resale and reuse communicated to the buyer at the time of sale, the patentee does not confer authority on the buyer to engage in the prohibited resale or reuse” and thus “does not exhaust its § 271 rights to charge the buyer who engages in those acts—or downstream buyers having knowledge of the restrictions—with infringement.” The court also held that “a foreign sale of a U.S.-patented article, when made by or with the approval of the U.S. patentee, does not exhaust the patentee’s U.S. patent rights in the article sold, even when no reservation of rights accompanies the sale.”

Lexmark embraces a very strong view of patent rights and a narrow view of the scope of exhaustion. It affirms that patent holders have wide latitude to segment and control distribution in the market channels for products covered by patents. This latitude is particularly wide with respect to limiting the import into the United States of patented goods sold in authorized sales in foreign markets even where restrictions on resale were not proven to have been communicated to foreign buyers. Even so, the court left open the possibility that foreign sales, under the right circumstances, may incorporate an implied license to import and use the product within the United States.

The majority opinion, written by Judge Taranto, and the dissenting opinion, written by Judge Dyk and joined by Judge Hughes, totals approximately 130 page and underscores the significance of the issues at stake. Suffice it to say that a detailed summary and complete analysis are beyond the scope of this short note. Whether one agrees with it or not, the majority opinion is a tour de force in its analysis and dissection of relevant precedent. Although it’s likely that Supreme Court review will be sought, it’s not entirely clear whether the Court will disturb the Federal Circuit’s rulings. So, stay tuned for further developments.

Restricted Sales in the U.S. Do Not Exhaust Patent Rights

When the Federal Circuit sua sponte granted en banc review, one of the two issues it addressed was whether the court should overrule Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992), which held that a restricted, lawful sale of a patented article does not give rise to patent exhaustion. Now, the full court has reaffirmed that holding. The majority methodically addressed each argument raised by the opponents of Mallinckrodt.

First, the court disposed of the Mallinckrodt issue as it had been framed. The United States, as amicus, posited that the issue turned on the distinction between an authorized sale by a patent owner versus an authorized sale by a licensee. The government had argued that patent rights are exhausted if the sale is by the patent owner, but not exhausted if the sale is by a licensee.

Rejecting the government’s argument, the court held that a “sale made under a clearly communicated, otherwise-lawful restriction as to post-sale use or resale does not confer on the buyer and a subsequent purchaser the ‘authority’ to engage in the use or resale that the restriction precludes.” Slip op. at 25. As the court explained, the Supreme Court had held that “a patentee can preserve its patent rights by authorizing a manufacturing licensee to make and sell a patented article under an otherwise-proper restriction, including a restriction on the buyer’s post-purchase use,” relying on General Talking Pictures Corp. v. Western Electric Co., 304 U.S. 175, op. on rehearing at 305 U.S. 124 (1938). And the Federal Circuit concluded that neither the statutory framework (35 U.S.C. §§ 154 and 271) nor any policy arguments provided any basis for making a distinction between patentee sales versus licensee sales. In fact, as the Federal Circuit majority noted, under the government’s theory, “[n]on-practicing entities would have greater power to maintain their patent rights than practicing entities.” Slip op. at 42.

The Federal Circuit also rejected the argument that Quanta Computer, Inc. v. LG Electronics, Inc., 553 U.S. 617 (2008) effectively overturned Mallinckrodt. The court concluded that:

Quanta did not involve the issue presented here. The facts defining the issues for decision, and the issues decided, were at least two steps removed from the present case. There were no patentee sales, and there were no restrictions on the sales made by the licensee. . . . . The two main issues decided by the Court in Quanta have no bearing on the issue of restricted sales by a patentee. The Court decided that exhaustion applies to method claims. . . . And the Court decided ‘the extent to which a product must embody a patent in order to trigger exhaustion.’ . . . . Only the third issue addressed by the Court in Quanta concerns restrictions on sales—though not patentees’ sales—and the Court’s discussion of that issue does not undermine Mallinckrodt’s ruling that a patentee can preserve its patent rights through restrictions on its sales.

Slip. op. at 29–30. Moreover, in the Federal Circuit’s view, “[i]nferring disapproval of Mallinckrodt by the Supreme Court in Quanta is unwarranted” because the Court said nothing about Mallinckrodt or its successor case B. Braun Medical even though, in Quanta, “the government prominently featured an argument that Mallinckrodt was incorrect and should be repudiated.” Slip. op. at 30.

These observations set the stage for the core of the court’s analysis. Quanta had formulated the exhaustion doctrine as follows: “The longstanding doctrine of patent exhaustion provides that the initial authorized sale of a patented item terminates all patent rights to that item.” Quanta Computer, Inc. v. LG Electronics, Inc., 553 U.S. 617, 625 (2008); see also Bowman v. Monsanto Co., 133 S. Ct. 1761, 1764 (2013) (“Under the doctrine of patent exhaustion, the authorized sale of a patented article gives the purchaser, or any subsequent owner, a right to use or resell that article.”). What does “authorized sale” mean? Those who maintained that Mallinckrodt should be limited, if not overturned, argued that a sale by a patentee was, by the mere act of the sale, authorized and so triggered exhaustion, permitting resales even in the face of a restriction unilaterally imposed by the patentee and known to the purchaser. The argument distinguished licenses, for there the licensor patentee would contractually define the ambit of authorization in the scope of the license, making sales outside of scope unauthorized.

The Federal Circuit firmly rejected this argument, concluding “that a patentee may preserve its § 271 rights when itself selling a patented article, through clearly communicated, otherwise-lawful restrictions, as it may do when contracting out the manufacturing and sale.” Slip op. at 38. Parsing Quanta, Bowman, and other Supreme Court articulations of the exhaustion doctrine, the majority found that such precedents did not require the interpretation advanced by the government or Impressions. In fact, the majority maintained that its conclusion “follows naturally from the statute.” Under the controlling language of “without authority,” reasoning that “a clear denial of authority leaves a buyer without the denied authority.” Id. at 38. While, in the court’s view, “[t]he exhaustion rule for unrestricted sales readily fits the language of § 271(a),” (emphasis in original), “it is quite a different matter to treat a sale as conferring on the buyer the very authority that is being denied through clearly communicated restrictions.” Id. at 38. Further, according to the majority the “essential tradeoff of the patent system—to provide a market-based reward in exchange for disclosure—is equally applicable whether the patentee sells or licenses another to make and sell.” Id. at 42. In addition, the majority warned that the “proposed distinction would also introduce practical problems. Where would the line be drawn along the spectrum from original patentees to assignees (e.g., regional assignees) to exclusive licensees (exclusivity being possible as to some but not all of the § 154 rights) to nonexclusive licensees?” Id. at 43.

Finally, the majority rejected any contention that antitrust law or “Lord Coke’s description of English general personal-property judge-made law” mandates a contrary conclusion. Similarly, the court considered the pragmatic “real-world consequences” and concluded that there was “no basis for predicting the extreme, lop-sided impacts the Court found plausible” in the copyright context of Kirtsaeng v. John Wiley & Sons, Inc., 133 S. Ct. 1351 (2013). Rather, the court recognized the benefits of the sales restrictions here, in which Lexmark had “a plausible legitimate interest in not having strangers modify its products and introduce them into the market with the quality of modifications (including ink refills) not subject to Lexmark’s control: lower quality of remanufactured cartridges could harm Lexmark’s reputation.” Slip op. at 56–57. Though this almost sounds like a goodwill protection basis for enforcing restrictions to trigger infringement liability, the Federal Circuit maintained that reputational and similar “interests are hardly unrelated to the interests protected by the patent law—the interests both of those who benefit from inventions and of those who make risky investments to arrive at and commercialize inventions, trademark or goodwill” Slip op. at 57. Since Impression had not “claimed that the restrictions at issue violate antitrust, patent-misuse, or similar constraints” that would invalidate the restrictions, those restrictions could be given effect.¹

In dissent, Judge Dyk “agree[d] with the government that Mallinckrodt was wrong when decided, and in any event cannot be reconciled with the Supreme Court’s recent decision” in Quanta. Dissenting op. at 2. He also noted that “[p]ost-sale restrictions were enforceable only as a matter of state contract law.” Id. at 5. Reviewing the same Supreme Court precedent as that majority, as well as additional cases, Judge Dyk concluded that “The rule articulated in the Supreme Court’s cases is consistent with the common law rule against restraints on the use or alienation of chattels.” Id. at 12.

A Foreign Sale, Even Without Restrictions, Does Not Exhaust U.S. Patent Rights

The second issue addressed by the en banc court was whether a foreign sale, made without any communication of a reservation of U.S. patent rights, triggers patent exhaustion, and whether to overrule Jazz Photo Corp. v. International Trade Commission, 264 F.3d 1094 (Fed. Cir. 2001), in view of the copyright case Kirtsaeng. The court held no:

[W]e adhere to the holding of Jazz Photo . . . that a U.S. patentee, merely by selling or authorizing the sale of a U.S.-patented article abroad, does not authorize the buyer to import the article and sell and use it in the United States, which are infringing acts in the absence of patentee-conferred authority. Jazz Photo’s no exhaustion ruling recognizes that foreign markets under foreign sovereign control are not equivalent to the U.S. markets under U.S. control in which a U.S. patentee’s sale presumptively exhausts its rights in the article sold . . . . We conclude that Jazz Photo’s no-exhaustion principle remains sound after the Supreme Court’s decision in Kirtsaeng . . . , in which the Court did not address patent law or whether a foreign sale should be viewed as conferring authority to engage in otherwise infringing domestic acts. Kirtsaeng is a copyright case holding that 17 U.S.C. § 109(a) entitles owners of copyrighted articles to take certain acts “without the authority” of the copyright holder. There is no counterpart to that provision in the Patent Act, under which a foreign sale is properly treated as neither conclusively nor even presumptively exhausting the U.S. patentee’s rights in the United States.

Slip op. at 8-9.

More importantly, the court recognized the market-based reasons for rejecting a foreign-exhaustion rule. “The statute gives patentees the reward available from American markets,” the court explained, and “[a] patentee cannot reasonably be treated as receiving that reward from sales in foreign markets.” Slip op. at 71. The court recognized that “American markets differ substantially from markets in other countries,” due in part to disparities in wealth and policies on market regulation and patent protection. Id. at 73-76. “For those reasons, a foreign sale, standing alone, is not reasonably viewed as providing the U.S. patentee the reward guaranteed by U.S. patent law.” Id. at 76.

Continuing its analysis, the majority turned to Supreme Court and appellate precedent. Only one case, Boesch v. Graff, 133 U.S. 697 (1890), directly addressed the question and held that U.S. patent rights are not exhausted by a foreign sale. The Federal Circuit recognized that the ruling did not “preclude an accused infringer from establishing that the U.S. patentee actually gave it a license, expressly or by implication.” Slip op. at 78–79.

Additionally, the fact that “Congress did act in three specific instances formally to guarantee a U.S. patentee the right to retain its U.S. rights despite selling abroad” was further evidence that U.S. rights are not exhausted by a foreign sale. Slip op. at 82. The majority cited Congress’ decisions in passing TRIPS, the related international agreement, and the more recent Trans Pacific Partnership. Id.

The majority also detailed the likely real-world consequences of maintaining the rule in Jazz Photo. The court observed that “[o]verturning Jazz Photo would plausibly cause significant disruption of existing practices adopted under the contrary law established by Jazz Photo and decades of prior case law.” Slip op. at 94.

All that said, the majority emphasized that, even under the Jazz Photo rule, the lack of exhaustion does not preclude the possibility that foreign sales establish a license, either express or implied. See slip op. at 85–92. Citing numerous appellate court decisions, the majority’s analysis explained past cases undertook “some assessment of the particular circumstances and language of foreign sales to determine if the U.S. patentee gave permission for importation.” Id. at 92.²

Again, Judge Dyk, along with Judge Hughes, disagreed with the majority. The dissent “would retain Jazz Photo insofar as it holds that a mere foreign sale does not in all circumstances lead to exhaustion of United States patent rights.” Dissenting op. at 21. But the dissent would agree with the government’s argument “that the foreign sale should result in exhaustion if the authorized seller does not explicitly reserve its United States patent rights.” Id. The dissent contended that “the centerpiece of the majority’s holding,” i.e., that Boesch announced “a doctrinal blanket ban on foreign exhaustion,” was not correct. Id. Judge Dyk also noted that “every one of the lower court decisions before Jazz Photo applied exactly the rule for which the government argues.” Id. at 22. In short, in Judge Dyk’s view, “the necessary accommodation between the interests of the rights holder and the unsuspecting buyer can only be achieved by the government’s proposal to put the burden on the U.S. rights holder to provide notice of a reservation of U.S. rights to the purchaser, an approach supported by the earlier lower court decisions and legislative action.” Id. at 29.

^{1. Importantly the court noted three aspects of Impression’s arguments narrowed the court’s focus. “First, we discuss only Lexmark’s sales to end users (and the resales and reuses deriving from those sales), because neither party has made an argument for distinguishing Lexmark’s sales to resellers. Second, we take as a premise that both the first purchaser and Impression as a repurchase had adequate notice of the single-use/no-resale restriction before they made their purchases; the adequacy of that notice is unchallenged. Thus, we do not have before us the questions that would arise, whether under principles governing bona fide purchasers or otherwise, if a downstream re-purchaser acquired a patented article with less than actual knowledge of such a restriction. Third, Impression has not contended that the particular restriction at issue gives rise to a patent-misuse defense, constitutes an antitrust violation, or exceeds the scope of the Patent Act’s express grant of exclusive rights over patented articles, 35 U.S.C. §§ 154, 271.” Slip op. at 13.}

^{2. For a general analysis of the doctrines of exhaustion, first sale and implied license, see §§2:35-2.38 and Chapter 10 of Nimmer and Dodd, Modern Licensing Law (Thomson West--2015-2016 ed.)}