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IP Alert: Restricted and Foreign Sales Do Not Give Rise to Patent Exhaustion

February 16, 2016

The doctrine of patent exhaustion restricts patent owners from asserting patent rights against a patented article after the initial authorized sale of the article by or on behalf of the patentee. This doctrine is subject to a number of limitations and qualifications, and it has been evolving recently in light of several recent court decisions.

As previously reported, on February 12, 2016, in Lexmark International v. Impression Products, Inc., the Court of Appeals for the Federal Circuit issued an order after hearing en banc two issues pertaining to patent exhaustion. Specifically, the court ruled that sales of a patented article within the U.S. that were subject to a “single-use-and-return” contractual restriction do not exhaust the patent owner’s rights to control the sale and use of that patented article. The court also ruled that sale of a patented article outside of the U.S. does not give rise to patent exhaustion within the U.S. The Lexmark decision adheres to the holdings of two previous Federal Circuit decisions pertaining to patent exhaustion. Namely, the decision reaffirms that the patent exhaustion principles set forth in Mallinckrodt, Inc. v. Medipart, Inc., and in Jazz Photo Corp. v. United States International Trade Commission remain controlling authority even after two recent Supreme Court decisions that called this Federal Circuit precedent into question namely, Quanta Computer, Inc. v. LG Electronics, Inc. and Kirtsaeng v. John Wiley & Sons, Inc.

Lexmark manufactures and sells printers and cartridges used in those printers. Defendant Impression Products obtains used Lexmark cartridges, has them refilled with toner, and then re-sells them in the U.S. without Lexmark’s approval. Lexmark sued Impression and a number of other defendants, alleging infringement under 35 U.S.C. § 271. Lexmark’s allegations are directed to two categories of toner cartridges. The first category includes cartridges that were initially sold in the U.S. under Lexmark’s “Return Program,” which allows customers to purchase patented Lexmark cartridges at a discount in exchange for an agreement to use the cartridge only once and then return the empty cartridge to Lexmark. The second category includes all cartridges that Lexmark initially sold outside of the U.S., and includes both Return Program and regular cartridges.

In the district court, Impression moved to dismiss Lexmark’s complaint of infringement against the domestically sold cartridges subject to the single-use restriction. Impression also moved to dismiss the complaint against the cartridges initially sold abroad and imported into the U.S. In both cases, Impression argued that Lexmark’s initial sales exhausted its patent rights in the cartridges.

The district court granted Impression’s motion to dismiss Lexmark’s claim of infringement against the domestically sold single-use cartridges. The Quanta Computer Supreme Court decision, which held that authorized sales of patented product from a licensee can exhaust a patent owner’s rights in those products even if the licensee’s arrangement with the patentee was subject to restrictions, was controlling. Although the Federal Circuit’s previous Mallinckrodt decision had rejected an exhaustion defense where a patentee sold a patented article subject to a single-use restriction similar to the one at issue in Lexmark, the court determined that Quanta Computer had effectively overturned the Mallinckrodt decision.

The district court then denied Impression’s motion to dismiss Lexmark’s claim of infringement against the cartridges initially sold extraterritorially. The district court relied on the Federal Circuit’s prior Jazz Photo decision, which held that an authorized first sale must have occurred within the U.S. for exhaustion to apply. Although the Supreme Court’s Kirtsaeng decision determined that a parallel “first sale” doctrine in copyright law did not have such a geographical limitation, the court concluded that this decision did not apply in the field of patent law.

On appeal of a stipulated judgment, after hearing oral arguments from both parties, the Federal Circuit sua sponte ordered en banc consideration of the following issues:
  1. Should the court overrule Jazz Photo in view of Kirtsaeng to the extent that Jazz Photo ruled a sale of a patented item outside the U.S. never gives rise to U.S. patent exhaustion?
  2. Should the court overrule Mallinckrodt in view of Quanta Computer to the extent that Mallinckrodt ruled that a sale of a patented article, when the sale is made under a restriction that is otherwise lawful and within the scope of the patent grant, does not give rise to patent exhaustion?
The Federal Circuit’s en banc opinion overturned the district court’s ruling regarding the cartridges sold pursuant to the Return Program. According to the majority opinion, the issue came down to an interpretation of the phrase “without authority” as that term is used in the U.S. patent code. 35 U.S.C. § 271(a) states that “whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention . . . infringes the patent” (emphasis added). While some sales may confer the purchaser with authority to sell or use the purchased article within the U.S., or import it into the U.S., sales that clearly communicate the denial of these rights do not.

The Federal Circuit ruled that the Mallinckrodt decision was still controlling authority, and was not overturned by the Supreme Court Quanta Computer ruling. The court distinguished Quanta Computer from Mallinckrodt, observing that the Supreme Court concluded that the patentee did not place any restrictions on the rights of its licensee to sell the patented product. Based on these statements, as well as the Supreme Court’s failure to explicitly reference the Mallinckrodt decision, the court reasoned that the Quanta Computer decision had not overruled Mallinckrodt’s holding.

The court then turned to the 1938 Supreme Court decision in General Talking Pictures Corp. v. Western Electric Co., which held that a patentee maintained patent rights against a buyer where a licensee made a first sale of a patented product subject to restrictions, and where the defendant buyer used the product contrary to the restriction. While the ultimate sale in General Talking Pictures was by the licensee and not the patentee, the court concluded that this was not a meaningful distinction. The court noted that that ruling otherwise would confer greater benefits to a non-practicing entity that merely licenses the patented product than to a practicing entity that makes and sells its own product.

The court also refuted the dissent’s arguments that any sale of a product, restricted or otherwise, grants the buyer “authority” under the meaning of section 271(a), stating that “[u]nless granting ‘authority’ is to be a legal fiction, a patentee does not grant authority by denying it.” Accordingly, the court concluded 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.”

The court also upheld the decision regarding the cartridges initially sold extraterritorially, reaffirming Jazz Photo’s holding that foreign sales do not exhaust a patentee’s patent rights in the U.S. The court ruled that the Kirtsaeng decision did not overrule Jazz Photo because Kirtsaeng only interpreted a section of the Copyright Act that had no corresponding provision in the Patent Act. The court noted that Kirtsaeng never addressed or mentioned patent law, nor did it cite to any patent cases in its ruling. Highlighting several distinctions between the Copyright Act and the Patent Act, the court focused on the Patent Act’s grant to a patentee of the right to exclude, and further noted that patent rights are more explicitly territorial than copyrights. The court stated that the Patent Act gives patentees the reward available in U.S. markets, and noted that a patentee cannot be considered to receive that reward from sales in foreign markets. According to the court, applying exhaustion to foreign sales would deprive the patentee to the reward in U.S. markets that the Patent Act intends to apply.

The decision left open the possibility that a foreign sale could bestow an implied license to the buyer to import the products into the U.S., but noted that Impression had not alleged the existence of such an implied license in this case. The court considered the application of a presumptive-exhaustion rule, whereby a foreign sale would create a presumption of exhaustion that the patentee could overcome by proving the foreign sale did not include an implied license to import the product into the U.S. However, the court declined to adopt this position, stating that some foreign governments may prevent a patentee from making such a restriction from importation into the U.S.

The court considered the practical impact that the rulings would have on various industries, referring to numerous amicus briefs that were provided to the court. The court indicated that there was no proof that there would be any negative impact in allowing the rulings of Mallinckrodt and Jazz Photo to stand, but indicated that there were negatives that could result if they were overturned. For example, a patentee’s reputation could be damaged if it could not prevent resellers from redistributing used products of an inferior quality. Moreover, many products, in particular pharmaceuticals, are often sold outside the U.S. at substantially lower prices than those charged domestically, and this practice “could be disrupted by the increased arbitrage opportunities that would come from deeming U.S. rights eliminated by a foreign sale made or authorized by the U.S. patentee.”

Judge Dyk dissented. He argued that Mallinckrodt was contrary to Supreme Court precedent when it was first decided, and is not reconcilable with Quanta Computer. Dyk argued that the use of the phrase “unconditional sale” in the Quanta Computer decision, which the majority argued distinguished Mallincktrodt’s “conditioned” restrictions, referred only to conditions on title, not restrictions on use. Regarding the foreign exhaustion issue, the dissent was in favor of the presumptive exhaustion rule that the majority considered, but denied. He then noted that refusing to find presumptive exhaustion could result in a lot of unintended infringement by buyers that purchase goods in foreign countries and bring them into the U.S., and that this would could seriously impair international trade.

Unless overturned by the Supreme Court, the Lexmark decision will serve as a watershed decision for the doctrine of patent exhaustion. Fitch Even attorneys will report on any Supreme Court action on this case in a future alert.

For more information, please contact Fitch Even partner Michael J. Krautner, the author of this alert.

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Note: A Fitch Even attorney represented Lexmark in earlier litigation relating to the Lexmark Return Program, but no longer represents Lexmark. This alert does not purport to represent any position of Lexmark or Impression or to constitute an opinion on the merits of either party’s position in the pending lawsuit.

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