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Lingering in Lexmark's wake, uncertainty about the limits of patent exhaustion

Introduction

According to ten judges of the Federal Circuit, a patent owner’s right to sue for infringement in the United States is not exhausted by sales of products abroad or by sales subject to valid post-sale contractual restrictions on use.  See Lexmark Int’l, Inc. v. Impression Prods, Inc., Nos. 2014-1617, slip op. (Fed. Cir. Feb. 12, 2016). In a 10-2 en banc decision which affirmed in part and reversed in part the lower court’s decision, the Circuit court held that U.S. patent rights need not be expressly reserved in foreign sales transactions to preserve the right to sue for infringement if the goods enter the United States downstream of the point of sale. The court further held that patent holders can enforce—under patent law—post-sale use restrictions imposed at the point of first sale not only against the buyer under contract law, but also against the buyer or a subsequent third party purchaser. A dissenting opinion authored by Judge Timothy Dyk and joined by Judge Hughes strongly disagreed with the majority’s opinion on both issues, cautioning that the majority’s decision cannot be reconciled with prior Supreme Court case law, sharply adding that “[w]e exceed our role as a subordinate court by declining to follow the explicit domestic exhaustion rule announced by the Supreme Court.” Lexmark Int'l, at __ (dissenting opinion) (slip op. at 2).1 The dissent also urged that presumptive exhaustion should apply to foreign sales, exhausting patent rights where those rights are not expressly reserved. 

Facts and Procedural Posture

Lexmark makes and sells printers and cartridges, and owns patents that cover its cartridges and their use. It is undisputed that the cartridges at issue were first sold by Lexmark, some abroad and some in the United States. The domestic cartridges at issue were sold at a discounted price but encumbered by a single-use/no-resale restriction at the point of sale. Impression Products is a reseller of Lexmark cartridges. Impression acquired both foreign-sold cartridges and restricted use domestic cartridges after a third party modified those cartridges in violation of the single-use/no-resale restriction and sold them to third parties. Lexmark sued Impression for patent infringement under 35 U.S.C. §§ 271(a) and (c).

Impression responded to Lexmark’s infringement suit with two motions to dismiss, arguing that although the cartridges it sells are covered by Lexmark’s patents, and those patents are valid, Lexmark’s right to sue is exhausted by Lexmark’s initial sale of the goods. The district court granted Impression’s motion to dismiss as to its sales of Lexmark’s cartridges that were sold in the United States, finding that Quanta overruled Mallinckrodt, and that post-sale restrictions did not prevent Lexmark’s patent rights from exhaustion after the first authorized sale of the cartridges. However, the district court found that patent exhaustion did not apply to Lexmark’s cartridges sold abroad because, it found, the Supreme Court’s copyright law decision in Kirtsaeng did not overrule the Federal Circuit’s patent law decision Jazz Photo. Following the district court’s decision, the parties entered into a Stipulated Final Judgment under 28 U.S.C. § 1295(a)(1) in favor of Impression as to cartridges sold in the United States and in favor of Lexmark as to cartridges sold abroad. After oral argument before a panel of three circuit judges, the Federal Circuit issued an order sua sponte taking the case en banc.

What Is Patent Exhaustion?

Patent exhaustion is an affirmative defense that acts as a limit on the patent owner’s statutory right to control what purchasers can do with an article embodying or containing a patented invention after its first authorized sale. Simply put, once a patented good is sold with the permission of a patent owner, no suit for infringement can be brought as to that article’s use or re-sale. The basic doctrine of patent exhaustion has been available as a defense since at least the mid-19th century, but has evolved over time to encompass the sale of incomplete articles that “substantially embody” a patented method or apparatus.  

Why is Lexmark So Controversial?

Lexmark has significant consequences for licensing agreements and international trade. The Federal Circuit received over thirty amicus curiae briefs on the en banc issue, in addition to those of the parties and the United States Government. The court’s diverse amici included industry organizations such as Pharmaceutical Research and Manufacturers of America, Biotechnology Industry Organization, Electronic Frontier Foundation, and Computer and Communications Industry Association, as well as industry giants themselves like LG Electronics, Google, Intel, and Costco, and influential academics and bar associations. 

One reason for the exceptional interest in this case is that although patent exhaustion is not a new doctrine, there is relatively little modern case law deciding its limits. Indeed, both the majority and dissenting opinions primarily rely on case law dating back to the mid-19th and early-20th centuries. The resulting opinion strikes at the heart of differences between property and contract law, with the law of property counseling against post-sale restrictions on validly conveyed chattels, and the law of contract permitting owners to freely set the terms of sale. Lexmark’s scholarly 122-page opinion belies the fact that the decision came down to two simple questions that are at the center of the dispute as applied in the patent exhaustion context: First, what is the meaning of “authorized sale” in the patent exhaustion context, and what impact does that have on use “without authority” in the context of 35 U.S.C. § 271(a)? Second, what is an “unconditional” sale? 

On the first question, the majority holds that an article is used “without authority” in violation of 35 U.S.C. § 271(a) if a particular use is expressly prohibited by contractual terms imposed at the time of initial sale. Crucially, the majority’s view extends to uses by a downstream purchaser even though the downstream purchaser is not a party to the initial transaction or even aware of the conditions imposed therein. In contrast, the dissent’s view is that “authority” turns not on whether the buyer had authority to use the purchased article in a particular way, but whether the seller had authority to sell it. According to the dissent, once a first sale is made by a party that has the full right and power to make the sale, Section 271(a) cannot be invoked to recover under the patent laws, leaving breach of contract as the sole remedy available to the patent owner. In other words, the dissent would hold that no action subsequent to an authorized sale can vitiate the initial “authority” conferred by the transfer of title itself. 

On the second question of conditional sales, the majority and dissent again approach the question from two very different perspectives. The majority’s view is that an “unconditional” sale is one made without contractual restrictions on the post-sale use of the sold article.  For example, per the majority, a sale is conditional if the relevant sale places use or sale restrictions on the first purchaser.  An arguable implication of the majority’s view is that contractual terms agreed to by the seller and first purchaser place a de facto encumbrance on the article, such that any downstream purchaser remains bound by the restrictions agreed to in the first sale. In contrast, the dissent states that an “unconditional” sale simply means that full title in the article is conveyed in the purchaser at the time of sale. The dissent explains that a sale is conditional as a matter of property law if, for example, the seller retains title until the buyer has paid the full purchase price. However, per the dissent, once title passes to a buyer the sale is at that point “unconditional,” irrespective of any contractual restrictions on use. The dissent would hold that although post-sale conditions may be valid and enforceable in contract, they are not enforceable as a matter of patent law. 

The majority and dissent thus depart not just as to the result, but on the very ground patent exhaustion stands on.  As to domestic sales with restrictions, the split implicates the first principles of property and contract law—i.e., whether contracting parties can impose post-sale restrictions on personal property that run with the property itself and bind third parties—lending Lexmark a significance that threatens to redefine patent law’s place in the common law landscape. As to foreign sales, the split likewise raises important questions regarding harmonizing patent law with general common law and copyright principles. Of more prosaic concern, the majority and dissent disagree as to whether the Supreme Court’s Quanta and Kirtsaeng decisions overruled their corresponding Federal Circuit decisions. Lexmark fails to give litigants a clear path forward, and may leave parties tempted to continue citing Supreme Court precedent until greater clarity on the precise limits of patent exhaustion is given.

The consequences of uncertainty in Lexmark’s wake are significant. Both the majority and dissent spend large portions of their opinions discussing the policy implications of their respective conclusions.

Lexmark’s Immediate Implications

Lexmark holds that patent owners wanting to retain the ability to sue downstream consumers for patent infringement after an initial sale of an article for use of said article can do so by placing contractual conditions on the article at the point of first sale. Nevertheless, the Lexmark rule is precariously situated at the moment and likely to be reviewed by the Supreme Court. Patent owners should proceed with caution when selling patented articles to purchasers who are either (a) likely to violate the terms of a sale agreement with post-sale restrictions; or (b) would be effectively judgment-proof in a breach of contract proceeding for financial reasons. On the downstream purchaser side, companies that acquire and resell potentially patented items risk substantial liability for patent infringement, and may be well-served to acquire authorization for their activities from patent owners directly. At the very least, such purchasers must take seriously any threatened litigation by patent owners who claim that the purchaser’s activities are unauthorized. In addition—and in contrast to copyright law—patentees may find comfort in knowing that patent law has territorial limits under which patentees need not expressly reserve rights in the United States in their foreign transactions. However, this holding is also strongly opposed, and patent owners may be well served to reserve rights in foreign transactions whenever practicable. Importers should not assume freedom to operate under patent law when purchasing articles initially sold abroad.

Going forward, all affected parties should be cautious in implementing any strategies based on the current law as set forth in Lexmark. The strength of the opposition to the Lexmark rule is likely to fuel Supreme Court review.  Indeed, Lexmark’s rule—which strongly favors patentee’s rights—may prove difficult to administer. As amici LG Electronics, Inc., Dell Inc., Google Inc., Intel Inc., et al. wrote in their brief in support of Impression, “modern devices include components from dozens—if not hundreds—of suppliers,” and a manufacturer may now be required to “trace the patent rights of every component it purchases and then negotiate appropriate license arrangements” with any manufacturer and sub-manufacturer. Similarly, Costco expressed concern in its amicus brief that it routinely sells genuine goods that were not purchased from the patentee, some of which were first sold abroad. On the other hand, the policy considerations at play in Lexmark are complicated and cut both ways. Biotechnology, medical device, and pharmaceutical industry companies generally favor the Lexmark rule because it preserves their ability to implement price discrimination strategies in both domestic and foreign sales, which in turn enables them to disseminate their technology across a broader swath of consumers including those who do not want, and cannot afford, the full bundle of “make, use, offer to sell or sell” rights granted under the patent. 

Likelihood of Supreme Court Granting Certiorari

In light of the issues raised by Lexmark—and in particular the split over whether two Supreme Court decisions overrule two earlier Federal Circuit decisions—Supreme Court review of Lexmark is likely. Should the Court fail to grant certiorari, litigants can expect continued uncertainty regarding the applicability of patent exhaustion where sales are subject to contractual restrictions or where goods were sold for the first time abroad without express reservation of rights in the United States.

Conclusion

Although the Federal Circuit’s decision purports to maintain the status quo regarding patent exhaustion, Lexmark has immediate implications for patentees, licensees, and downstream consumers alike. The dissent’s treatment of Quanta and Kirtsaeng shows that patent exhaustion remains controversial, and the Supreme Court is likely to review Lexmark. In the absence of a clear articulation of the patent exhaustion rule following Supreme Court review, we can expect uncertainty regarding the patent exhaustion rule’s application to contractually restricted and foreign sales to persist.


1 The majority fou​nd that Quanta Computer, Inc. v. LG Electronics, Inc., 553 U.S. 617 (2008)did not overrule Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992), and that Kirtsaeng v. John Wiley & Sons, Inc., 133 S. Ct. 1351 (2013)—a copyright decision—did not overrule Jazz Photo Corp. v. International Trade Comm’n, 264 F.3d 1094 (Fed. Cir. 2001).  

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