Under the doctrine of patent exhaustion, otherwise referred to as the “first sale doctrine,” the initial authorized sale of a patented item exhausts a patent owner’s rights to further control the sale, offer for sale, or use of the item. Bowman v. Monsanto Co., 133 S. Ct. 1761 (2013).  In other words, once a patented article is sold to a buyer in a sale authorized by the patentee, the buyer, or any subsequent purchaser of the article, is free to use or resell the article without restraint from patent law.  The doctrine of patent exhaustion thus seeks to prevent patent holders from receiving any overcompensation or potential double recovery, under the assumption that the patent owner has already received a just reward from the initial sale.  Procedurally, an accused infringer can raise patent exhaustion as an affirmative defense in a patent infringement action.

While the doctrine of patent exhaustion seems relatively straight-forward and simple in theory, real-world applications of the doctrine have been anything but straight-forward or simple. This is not surprising since economic transactions and license agreements are becoming more complex in today’s ever constantly changing society and ever increasingly competitive markets.  Additionally, there are only a handful of modern Supreme Court and Federal Circuit decisions dealing with patent exhaustion.  Further, the available cases often fail to provide sufficient guidance as to the scope and reach of exhaustion as applied to the myriad of factual situations that can arise in modern commercial transactions involving patented products or processes.

In an effort to bring much needed clarity to patent exhaustion issues, the Federal Circuit handed down a 10-2 en banc decision in the closely followed and highly anticipated case Lexmark International, Inc. v. Impression Products, Inc., Nos. 14-1617, -1619 (Fed. Cir. Feb. 12, 2016).

Background

Lexmark International, Inc. makes and sells printers and toner cartridges, and also owns a number of patents that cover its toner cartridge technology. Lexmark offers buyers a choice of purchasing a “Regular Cartridge” at full price without any restrictions, or purchasing a “Return Program Cartridge” at a discounted price subject to a single-use and no-resale restriction.

Impression Products, Inc. acquired “Return Program Cartridges” for sale domestically and abroad, and had an overseas third party physically modify the cartridges to configure them for re-use. The modified cartridges were then imported and resold in the U.S. without Lexmark’s authorization.  Lexmark sued Impression in the District Court for the Southern District of Ohio for patent infringement, alleging that Impression directly violated Lexmark’s single-use and no re-sale restriction.  Impression responded with a motion to dismiss based on the patent exhaustion defense, arguing that because Lexmark already sold those toner cartridges domestically and abroad, Lexmark was precluded from suing for infringement despite the single-use and no-resale restrictions placed on the “Return Program Cartridges.”

In advancing its defense, Impression argued that two prior Federal Circuit patent exhaustion cases, Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992) and Jazz Photo Corp. v. International Trade Comm’n, 264 F.3d 1094 (Fed. Cir. 2001), were overruled, respectively, by two Supreme Court cases, Quanta Computer, Inc. v. LG Electronics, Inc., 533 US. 617 (2008) and Kirtsaeng v. John Wiley & Sons, Inc., 133 S. Ct. 1351 (2013).

The district court agreed with Impression that Quanta overruled Mallinckrodt, and dismissed Lexmark’s infringement claim relating to the restricted cartridges sold in the U.S.  The district court, however, disagreed that Kirtsaeng overruled Jazz Photo, and denied Impression’s motion to dismiss Lexmark’s infringement claim involving the cartridges sold overseas.  Both parties then appealed.

Domestic Sale Issue

In Mallinckrodt, which involved domestic sales of patented articles, the Federal Circuit held that use restrictions, such as “Single Use Only” conditions, do not exhaust patent rights “[u]nless the condition violates some other law or policy.” See Mallinckrodt, 976 F.2d at 708.  As noted above, Impression had argued that Mallinckrodt no longer remains good law because it was implicitly overruled by Quanta.

In Quanta, LG owned patents that cover computer chips.  LG had licensed Intel to manufacture and sell chips that used the patents.  The licensing agreement included a disclaimer provision stipulating that no license was given to Intel’s customers to combine the licensed Intel products with non-Intel components in ways that practiced the LG patents.  In addition, a separate Master Agreement required Intel to notify its customers that they were not licensed to practice the LG patents by combining Intel products with non-Intel products.  The Supreme Court held that Intel’s sale of the chips to its customer and computer maker, Quanta, exhausted LG’s patent rights.  More specifically, the Court noted that because the patent license agreement itself permitted the licensee, without any conditions or limitations, to “make, use, [or] sell” products, the sale between Intel and Quanta exhausted LG’s patent rights, thus allowing Quanta to freely use the patented chips purchased from Intel.

In an attempt to clarify any tension between Mallinckrodt and Quanta, the Federal Circuit in Lexmark emphasized that the Supreme Court’s Quanta decision focused on the sale of a patented item by a manufacturing licensee—not by a patentee.  Additionally, the Federal Circuit further distinguished the two cases by clarifying that Quanta did not involve a sale subject to a restriction, but rather involved a licensee’s sales not subject to any conditions or limitations.  As such, the Federal Circuit held that Quanta did not overrule Mallinckrodt, and that Lexmark’s single-use or no-sale restrictions did not exhaust its patent rights.

Foreign Sale Issues

Impression further argued that Lexmark’s foreign sales of its patented toner cartridges precluded Lexmark from alleging infringement based on the toner cartridges that were physically modified overseas and imported into the U.S. Even though Jazz Photo held that U.S. patent rights are exhausted only by a first sale in the U.S., and not sales made abroad, Impression argued that Kirtsaeng overruled Jazz Photo.

The Federal Circuit in Lexmark rejected this argument, holding that Kirtsaeng was a copyright case that focused on whether foreign copies of a copyrighted work were subject to the first sale doctrine embodied in Section 109(a) of the Copyright Act, and noting that there is no corresponding language in the Patent Act.  The Federal Circuit further noted that while Kirtsaeng held that such foreign sales of copyrighted works did indeed exhaust a copyright owner’s exclusive distribution right, Kirtsaeng was limited to copyrighted works and is not controlling as to patent exhaustion.  Thus, the Federal Circuit upheld Jazz Photo and reaffirmed that patent exhaustion doctrine is territorial, such that “United States patent rights are not exhausted by products of foreign provenance.” Jazz Photo, 264 F.3d at 1094.  As a result, Lexmark’s foreign sales of the toner cartridges did not exhaust its patent rights.

Dissent

In dissent to the Federal Circuit’s decision, Judge Dyk argued that Kirtsaeng created a presumptive exhaustion rule in which a patentee’s failure to secure its patent rights would result in automatic exhaustion.  Additionally, the dissent argued that the majority opinion upholding Mallinckrodt is irreconcilable with Quanta, where Supreme Court precedent supports a finding that patent rights are always exhausted upon the first authorized sale.  The dissent went so far as to declare that “the majority’s justification for refusing to follow Supreme Court authority establishing the exhaustion rule misconceives our rule as a subordinate court.”

Lexmark’s Implications and Practice Tips

At first glance, Lexmark’s holdings are undoubtedly a significant victory for patent holders.  One particularly important outcome in this regard is that, by using a contractual restriction at the time of first sale, patent owners may avoid exhaustion and thus retain the ability to sue downstream consumers for patent infringement.

With Lexmark’s strong dissent and still apparent tensions with Quanta, however, Supreme Court review appears likely.  Until then, Lexmark provides some practice tips, especially for subsequent and downstream purchasers.  To limit the risk of substantial liability for patent infringement, businesses that regularly purchase products covered by U.S. patents should carefully consider whether and to what extent exhaustion applies.  This is particularly important with many patentees now expanding into global markets and conducting sales and transactions locally and overseas simultaneously.  This globalization increases the complexity of determining whether the first authorized sale occurred in the U.S. or abroad, and thus whether patent exhaustion is an issue.  In addition, a purchaser of U.S. patented items from the patentee through global transactions would be well advised to negotiate a waiver of the patentee’s U.S. rights to exclude.  This is especially true if the purchaser intends to import the items into the U.S. after refurbishment or incorporation into other products.