Restrictions Put on Earning Royalties after the Patented Product is Sold

By Michael Fuller, Nerac Analyst

Despite being “intellectual” property and therefore intangible, patents are property as much as land or a car can be property. Because patents are property, their owners have the right to sell in part (licensing) or whole (assignment) their patents to others. Typically, patents are licensed by the patent holder in exchange for royalties. The patent holder may still retain some rights to
control how the licensee uses the patented technology, but that right does not extend beyond the licensee to whoever may buy the patented technology from the licensee. This is the doctrine of patent exhaustion (sometimes known as the “first sale” doctrine in copyright law), and it is the focus of the Quanta Computer v. LG Electronics case, which the US Supreme Court recently decided in favor of Quanta. From a patent holder’s perspective, it continues a trend by the Supreme Court over the past few years (see most notably, KSR v. Teleflex) of reversing Federal Circuit decisions that tend to shift the balance towards patent holders versus patent applicants who wish to become patent holders (and perhaps compete with existing patent holders).

Background
In 1999 LG Electronics (LGE) purchased three U.S. patents relating to computer technology, which it later licensed to Intel. Each patent claimed compositions of matter (for example, an article or device) as well as methods (such as processes for making or incorporating the composition of matter into something else). As part of the licensing agreement between LGE and Intel, LGE was entitled to request royalties from whoever purchased these patented products from Intel for use in their products. (Interestingly, the licensing agreement states that “nothing herein shall in any way limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products.”) Intel in turn sold these patented components (microprocessors and chipsets) to its customers through a separate agreement that informed the buyers that the license Intel had with LGE did not extend to Intel’s buyers. Quanta (and other companies listed as petitioners in this case) incorporated these Intel components into their products without paying royalties to LGE.

In the first round of litigation, the trial court sided with Quanta, relying on a case from 1942 (Univis) involving lenses for eyeglasses. There, the Supreme Court first held that, with respect to patent exhaustion, “the traditional bar on patent restrictions following the sale of an item applies when the item sufficiently embodies the patent—even if it does not completely practice the patent—such that its only and intended use is to be finished under the terms of the patent.”

LGE appealed to the Federal Circuit, which held that LGE was entitled to the royalties it requested in their contract with Intel, because LGE did not license Intel to sell Intel’s products to Quanta for use in combination with non-Intel products.

Appeal to the Supreme Court
In finding for Quanta, the Supreme Court quoted two cases, one from 1873 (Adams v. Burke, regarding a license of patented coffin lids) and one from 1917 (Motion Picture Patents), along with the Univis case that the trial court cited. Both cases reiterated the proposition that (quoting Motion Picture Patents) “the right [of a patent holder, here LGE] to vend is exhausted by a single, unconditional sale, the article sold being thereby carried outside the monopoly of the patent law and rendered free of restriction which the vendor may attempt to put on it.”

LGE also argued that method claims can’t be sold in the same way as an article or device, and therefore should not be held subject to the doctrine of patent exhaustion. The Court disagreed, holding that methods may nonetheless be “embodied in a product, the sale of which exhausts patent rights.”

How this Ruling Affects Patent Holders?
The Supreme Court told patent holders that the doctrine of patent exhaustion is more expansive than patent holders had thought―or hoped. This is especially important as technological advancements continue to be made that involve multiple elements, each of which may be separately patentable, being combined into something new. According to Quanta, as long as the product into which the patented component is incorporated substantially embodies what is disclosed in the patents, the doctrine of patent exhaustion is triggered after the first sale of the patented product, and the patent holder is thereafter precluded from claiming royalties from further applications of that same patent.

Here, LGE’s rights to royalties were limited to their licensing agreement with Intel because the components Intel sold to Quanta and others were useless by themselves—they had to be incorporated into bigger systems, and these systems, in the minds of the Supreme Court, substantially embodied what was disclosed in the patents: a functioning computer. To extend patent exhaustion beyond the first buyer in this instance would have broadened the limited monopoly guaranteed by the Constitution to patent owners, which could have increased the costs of research and development of new products, thereby slowing innovation.

Taking It Beyond Electronics
Because the Quanta case offers a very good technology-based example of patent exhaustion, I will offer a life science-based example. Suppose a particular drug was marketed whose bioavailability, and therefore efficacy, relied on a particular chemical formulation that another company patented that prevented the breakdown of the active ingredient in the stomach. If the owner of the active ingredient patent was forced to license the formulation patent in order for its drug to work, and the owner of the formulation patent demanded royalties from the active ingredient patent holder as well as any other downstream purchasers of the drug, a chain of events would be triggered:

• The owner of the active ingredient patent would probably spend some time devising its own patentable formulation.
• That in turn would impede R&D efforts while resources were dedicated to finding their own patentable formulation.
• And that in turn would increase the cost of the marketed drug.

Practically speaking, it is easy to see why the Supreme Court ruled unanimously as it did in Quanta v. LG. This ruling should deter patent holders from attempting to extend the reach of their patent license beyond the licensee into the pockets of anyone purchasing the product—the type of activity that the patent exhaustion doctrine was meant to prevent.