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  • The Collision of Licensing Provisions and Patent Law

    September 09, 2008

    The success of today’s high technology companies is greatly dependent on the acquisition, protection and commercialization of technology. These technology companies may attain such protection when they file for and are granted patents for their inventions. As a part of their commercialization approach, these companies grant to third parties the right to license their inventions and technology. The high technology company, as the licensor, and the third party, as the licensee, negotiate and enter into a license agreement that sets forth the terms and conditions of the licensing deal. When patents are involved in any such contract, the licensor must be careful to understand what patent rights are granted or retained. The failure to clearly and carefully delineate the respective rights of the parties could lead to the unintended exhaustion of patent rights of the licensor. In Quanta Computer v. LG Electronics, 553 U.S. __ (2008), the U.S. Supreme Court recently issued its opinion regarding a patent infringement case involving patent rights, licensing provisions and the exhaustion doctrine. The outcome of this case has significant ramifications on the interpretation of patent license agreements and the ability of patent licensors to seek royalties from third parties.

    LG Electronics, Inc. (“LGE”) owns several patents relating to the computer components and assemblies. Some of LGE’s patents cover components such as microprocessor chips and chipsets, while other patents covered the systems and methods associated with these components and assemblies. LGE entered into a patent license agreement with Intel Corporation (“Intel”) for use of LGE’s components in Intel’s products. The parties also entered into a separate master agreement under which Intel agreed to give notice to its purchasers that the license granted to Intel by LGE did not authorize third parties to combine the products with non-Intel products. Quanta Computer Inc. (“Quanta”) purchased products from Intel and installed them in computers in combination with non-Intel products. Pursuant to the separate master agreement between Intel and LGE, Intel notified Quanta that such license grant does not extend to combining the products with non-Intel products. LGE brought suit against Quanta for patent infringement asserting that Quanta infringed upon the claims of LGE’s patents – not for the components themselves – but rather for systems and methods of combining licensed components with non-Intel components in its computers.

    The United States District Court for the Northern District of California granted summary judgment of non-infringement to Quanta holding that Intel’s sale to Quanta generally exhausted LGE’s patent claims, but the court declined to find that LGE’s method claims were exhausted. The court also held that Quanta could not infer a license from Intel’s sale of LGE-licensed components because Intel expressly notified Quanta that the license did not cover non-Intel product combinations. On appeal, the Court of Appeals for the Federal Circuit reversed in part, concluding that the exhaustion doctrine does not apply to an expressly conditional sale or license, and that the notice provided by Intel to Quanta created a conditional sale, therefore the exhaustion doctrine did not apply. Quanta Computer v. LG Electronics, 453 F.3d 1364 (Fed. Cir. 2006), rev’d, 553 U.S. __ (2008).

    A review of the exhaustion doctrine is required to understand the issues of this case. The exhaustion doctrine (also known as the “first sale doctrine”) is common under copyright and patent law. Under copyright law, once a copyrighted work is sold to any party, such party can sell, distribute or lend that one copy to another party without infringing any copyrights. For example, if you purchase a DVD of a movie, you have the right to lend or resell that copy of the DVD of the movie to a friend.

    Under patent law, the exhaustion doctrine generally provides that a patent holder’s exclusive rights, as derived from a patent claim, end at the first sale of a patented product. The patent exhaustion doctrine is triggered by an unconditional sale. An unconditional sale of a patented product exhausts the patentee’s right to control the purchaser’s use of the product. The theory is that a patent holder has bargained for and received an amount equal to the full value of the products and that he gives up the right to restrict that use.

    The patent exhaustion doctrine also applies to an incomplete product that has no substantial use other than to be manufactured into a completed patented and allegedly infringing article. Cyrix v. Intel Corp., 846 F. Supp. 522 (E.D. Tex 1994), aff’d without op., 42 F. 3d 1411 (Fed. Cir. 1994) (holding that the patent holder’s microprocessors could not be used for any commercially viable purpose without necessarily forming a combination covered by the patent claims); United States v. Univis Lens Co., 316 U.S. 241 (1942) (holding that the sale of eyeglass lens blanks that partially practice a patent exhausted the method patents that were not completely practiced until the blanks were ground into fully completed eyeglass lenses). The unconditional sale of an uncompleted product which embodies a claimed invention, or in other words, contains essential features of a patented invention, exhausts the patent holder’s rights so far as it may be embodied in a particular product without other substantial use. Univis, 316 U.S. at 248-251.

    However, the patent exhaustion doctrine may not negate a lawful express restriction. An unconditional sale, required for patent exhaustion, cannot exist where there is a lawful express restriction. In such a transaction, one may reasonably infer that the parties negotiated a price that reflects only the value of the use rights conferred by the patent holder. As a result, express conditions accompanying the sale or license of a patented product are generally upheld. B. Braun Med. Inc. v. Abbott Labs, 124 F.3d 1419 (Fed. Cir. 1997). However, it must be clear that the purchaser fully understood the restriction and agreed to such restriction. Such express conditions are contractual in nature and are subject to contract and any other applicable law.

    Furthermore, a licensor may seek to exclude the rights to combination claims where the component and the combination are separate and distinct. Accordingly, a computer manufacturer may not obtain a right to the combination claims merely by purchasing or licensing a component. The patent holder may argue that these combination patents would not be exhausted until a full royalty is recovered for the combination via the sale of the component. A patent holder may take the position that the component patents are separately enforceable from the combination patents. Under this position, a patent holder could seek additional royalties.

    The application of the patent exhaustion doctrine has been determined by the U.S. Supreme Court’s interpretation of the above principles. The Court held that the patent exhaustion doctrine extends to patent method claims. Although patented methods may not be sold in the same way as a component, the methods nonetheless may be embodied in a product, the sale of which exhausts patent rights. LGE failed in its attempt to make a distinction between the components which Quanta purchased from Intel and LGE’s patented systems and methods and failed in its argument that a sale of a patented component does not exhaust rights in the independently patented systems and methods to which the component belongs. LGE argued that it had granted Intel a license to manufacture and sell the components and another license to practice LGE’s systems and method patents. In making its decision, the Court recognized that eliminating exhaustion for method claims would seriously undermine the exhaustion doctrine. Patent holders could avoid the exhaustion doctrine by simply including method claims in their patents. For example, although a licensee would be authorized to sell a computer assembly, the downstream purchasers could nonetheless be liable for patent infringement. Such a result would violate longstanding principles.

    The Court further held that the sale of the microprocessors and chips was essentially a sale of an uncompleted product which contained essential features of a patented invention, and such sale exhausted the patent holder’s rights so far as they may be embodied in a particular product without other substantial use. Quanta successfully argued that the sale of the microprocessors and chips exhausted LGE’s patent rights in the same way as the sale of the eyeglass lens blanks exhausted the patent rights in the Univis case. The microprocessors and chips had only one real use which was as a part of a computer. The Intel products cannot practice the LGE patent claims until they are combined with other components and assemblies in a computer. The patent exhaustion doctrine is triggered by the sale of components that essentially, even if not completely, embody the invention. Otherwise, patent holders could authorize the sale of computers that are complete with the exception of one minor step and extend their rights through each downstream purchaser all the way to the end user.

    The Court finally found nothing in the license agreement that limited Intel’s ability to sell its products practicing the LGE patents. Such restrictions were not included in the license agreement between LGE and Intel. Quanta did not dispute that patentees can engage in conditional sales, however, Quanta argued that patent holders can and should negotiate specific contracts with purchasers if they want to impose restrictions on their products. LGE unsuccessfully argued that notice, as required under the separate master agreement between LGE and Intel, was given by Intel to its purchasers that the license granted to Intel by LGE did not authorize third parties to combine the products with non-Intel products. Because Intel was authorized to sell Intel’s products to Quanta, the patent exhaustion doctrine prevented LGE from asserting its patent rights with respect to Intel’s products. The Court acknowledged that LGE may have other contract rights, but refused to express an opinion as to whether contract damages might be available even though exhaustion operates to eliminate patent damages.

    The Supreme Court’s decision has reaffirmed the patent exhaustion doctrine and clarified the extent of a patent holders’ license rights. The Court’s decision in favor of Quanta, finding exhaustion upon LGE’s first sale to Intel, reasonably limits a patent holders’ rights. Patent holders are prevented from circumventing the patent exhaustion doctrine by simply including method claims in their patents so that they can exercise control over post-sale use of their patented components. The Court made clear that a sale of an uncompleted product, which contains essential features of a patented invention, exhausts the patent holder’s rights so far as they may be embodied in a particular product without other substantial use. The patent holders are not able to collect royalties from downstream users unless the licensor and licensee mutually consent to express contractual provisions in their license agreement. A decision for LGE would have potentially expanded patent holders’ rights by severely undermining the patent exhaustion doctrine and allowing the patent holder to collect royalties from multiple users as a product works its way from manufacturer to the end user. These increased costs would have most likely been passed down to the end user consumers.

    1 Vasilios Peros is founder and principal of Law Office of Vasilios Peros, P.C. His practice is focused primarily on business, technology and intellectual property law. He can be reached at (410) 274-2053 and VPeros@PerosLaw.com.

    2 This article is provided for informational purposes only and should not be construed as a legal opinion or legal advice. The reader should not rely on this article in making business, legal or other decisions on any matter without first consulting an attorney regarding any such decision or undertaking.