Quanta Computer, Inc. v. LG Electronics, Inc. (06-937)

Oral argument: Jan. 16, 2008

Appealed from: United States Court of Appeals for the Federal Circuit (July 7, 2006)

PATENT LAW, PATENT EXHAUSTION DOCTRINE, INFRINGEMENT, LICENSE, ROYALTY

In the latest Supreme Court case on patent law, LG Electronics, Inc. (LGE) sued Quanta Computers, Inc. (Quanta) for patent infringement. A patent license agreement between LGE and Intel allowed Intel to use LGE’s patents but required Intel to notify its customers, including Quanta, that its license did not extend to third-party purchasers’ combinations of Intel and non-Intel components. LGE alleges that Quanta infringed LGE’s patents by combining Intel and non-Intel components. LGE argued that Intel’s sale to Quanta did not exhaust LGE’s rights as a patent holder, allowing LGE to sue Quanta. Quanta, however, argued that Intel’s authorized sale to Quanta exhausted LGE’s patent rights. The Federal Circuit agreed with LGE, holding that the exhaustion doctrine did not apply because the notice provided by Intel to Quanta created a conditional sale, and that sales of patented devices do not exhaust a patent holder’s methods claims. In deciding this case, the Supreme Court will determine whether a patent holder can sue customers who use patented components purchased from licensees. The outcome of this case will clarify the exhaustion doctrine generally and will help define the scope of patent holders’ rights, including their ability to collect royalties from and sue downstream users of their patents.

• [Question(s) presented]
• [Issue(s)]
• [Facts]
• [Discussion]
• [Analysis]

Question(s) presented

Whether the Federal Circuit erred by holding, in conflict with decisions of this Court and other courts of appeals, that respondent’s patent rights were not exhausted by its license agreement with Intel Corporation, and Intel’s subsequent sale of product under the license to petitioners.

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Issue(s)

Can a patent holder extract royalties from not only a licensed user of its patent, but also from the licensed users’ subsequent purchasers?

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Facts

LG Electronics, Inc. (LGE), a Korean company, owns patents that relate to personal computers. See LG Electronics, Inc. v. Bizcom Electronics, Inc., 453 F.3d 1364, 1368 (Fed. Cir. 2006). Some LGE patents cover components such as microprocessors and chipsets, while others cover the systems and methods that combine these components with other devices to produce operational computing systems. See Brief for Respondent at 4–5. In September of 2000, LGE licensed its patents to Intel for use in Intel’s products in a Patent License Agreement. See Brief for Petitioners at 8. However, this license did not extend to third parties that combined LGE-licensed Intel products with non-Intel products. See id. In a separate Master Agreement, Intel also agreed to notify its customers that Intel’s LGE licenses would not cover their customers’ combined Intel and non-Intel products. See id. at 8–9. Quanta Computer, Inc., a Taiwanese company, is an Intel customer that incorporates Intel’s products into its computers. See id. at 9. Intel sent Quanta the required notice that Intel’s LGE patent license excluded combinations of Intel and non-Intel products. See id. Quanta, however, continued to combine Intel and non-Intel components. See id.

Article I, Section 8 of the United States Constitution grants Congress the power to make laws to “promote the progress of science and useful arts” by giving inventors exclusive rights to their discoveries for a limited time. Under the patent law in 35 U.S.C. § 271, “whoever without authority makes, uses, offers to sell, or sells any patented invention” infringes the patent holder’s rights. However, some limitations to patentees’ rights exist. For example, under the exhaustion doctrine, the authorized sale of a patented device ends (or exhausts) the patentee’s rights to control use of the purchased patented device. See Mark R. Patterson, Reestablishing the Doctrine of Patent Exhaustion, Patently-O Patent Law Blog, Nov. 19, 2007. The patent exhaustion doctrine is longstanding; the Supreme Court decided the often-cited exhaustion case Adams v. Burke, where a patentee lost the right to restrict after-sale use of its patented coffin-lids, in 1873.

In 2000 and 2001, LGE sued Quanta (and other companies who subsequently settled with LGE) for patent infringement in the United States District Court for the Northern District of California. See LG Electronics, Inc., 453 F.3d at 1368. LGE claimed that Quanta infringed LGE’s patents by combining licensed components with non-Intel components in its computers. See LG Electronics, Inc., 453 F.3d at 1368. The district court granted summary judgment of noninfringement to Quanta. See id. The district court held that, because Intel expressly notified Quanta that LGE’s license did not cover Intel and non-Intel product combinations, Quanta could not infer a license from Intel’s sale of LGE-licensed components. See id. at 1369.Furthermore, the district court held that Intel’s sale to Quanta exhausted LGE’s systems patents claims, but that LGE’s methods claims were not exhausted. See id.

On appeal to the United States Court of Appeals for the Federal Circuit, which hears all appeals for patent infringement cases, LGE argued that the exhaustion doctrine “does not apply to an expressly conditional sale or license.” See LG Electronics, Inc., 453 F.3d at 1369. The Federal Circuit agreed, reversing the district court by holding that the notice provided by Intel to Quanta created a conditional sale, and that the exhaustion doctrine therefore did not apply. See id. at 1370. Further, the Federal Circuit upheld the district court’s holding that the “the sale of a device does not exhaust a patentee’s rights in its methods claims.” See id. In September of 2007, the Supreme Court of the United States accepted Quanta’s petition for certiorari to consider whether the LGE-Intel agreement and Intel’s sale to Quanta exhausts LGE’s rights over its patented components and methods.

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Discussion

Can a patent holder require purchasers beyond the initial purchaser of a patented device to pay royalties? By hearing Quanta Computers, Inc. v. LG Electronics, Inc. the Supreme Court continues its recent trend of reviewing patent cases. The Court’s decision in Quanta Computers could significantly affect the value of a patent by determining whether a sale of a product under license exhausts a patent holder’s rights.

Quanta argues that an authorized sale of a product that “embodies essential features of the patent and has no reasonable non-infringing use” exhausts the rights of the patent holder. See Brief for Petitioners at 15. Quanta also contends that exhaustion applies to method claims, and that the exhaustion doctrine protects against patentees’ anti-competitive conduct. See id. at 35, 50. Further, Quanta argues that restrictions on use of a patented device should be resolved by contract law, not patent law. See id. at 23.

LGE responds, however, that a sale of a patented component does not exhaust rights in the system to which the component belongs. See Brief for Respondent at 13. LGE further maintains that the license it granted to Intel for LGE’s patents did not extend to third parties like Quanta because of Intel’s express notifications to its customers; therefore, the Intel-Quanta sale did not exhaust LGE’s patent rights. See id. at 9. In addition, LGE argues that contract law provides less adequate protections than patent law, and that patentees can restrict licensees if the restrictions reasonably relate to patent rights. See id. at 23, 39.

A ruling for Quanta, argues LGE and several amici, would interfere with the traditional rights of companies to modify their transactions through negotiations and agreements. Yahoo! Inc. argues that the Federal Circuit holding, which treats the exhaustion doctrine as a default rule that parties can agree to modify, provides the flexibility needed for innovation. See Brief of Amicus Curiae Yahoo! Inc. in Support of Affirmance of the Federal Circuit at 19. Allowing parties to negotiate around patent exhaustion promotes economic efficiency, Yahoo! argues, by granting purchasers access to patents they otherwise may not be able to afford, and providing profit incentives to patent holders to continue innovating and distributing their products commercially. See id. at 19–20. Moreover, several law professors argue that using the exhaustion doctrine to prevent parties from settling patent and licensing disputes by agreement interferes with principles of freedom of contract. See Brief of Various Law Professors as Amici Curiae in Support of Respondent at 2–3. The professors contend that the freedom of patent holders and licensees to contract about patent rights promotes innovation and competition. See id. at 4. LGE’s brief further suggests that without adequate patent law protection, inventors might withhold innovative, profitable inventions from the marketplace. See Brief for Respondent at 33.

However, the prospect of a decision for LGE causes concern among downstream users of patented products. Dell Inc. and Hewlett-Packard Company, two computer manufacturers that purchase and incorporate Intel products into their computers, filed an amicus brief with Cisco Systems and eBay in support of Quanta. These companies argue that a decision for LGE could allow many “new, and very substantial, abusive patent infringement claims” against anyone who sells or uses a patented device. Id. at 3–4. IBM, another technology company supporting Quanta, argues that upholding the Federal Circuit would ultimately result in higher costs to consumers. See Brief of Amicus Curiae International Business Machines Corp. (IBM) in Support of Petitioners at 32. IBM also notes that patent issues stemming from a unilateral notice to purchasers about one component from a complex IT product—which “regularly involves the combination of 50, 100, even 1,000 or 5,000 different patent rights”—might even prevent a product from reaching the market. Id. at 31–32. Finally, Quanta notes that a decision for LGE could allow LGE to sue not only Quanta, but even computer end consumers, for infringement. See Brief for Petitioners at 52–53.

Quanta Computers has also generated interest from organizations and industries that use patent law but support neither Quanta nor LGE. In its amicus brief, the Biotechnology Industry Organization argues that the patent exhaustion doctrine should not apply to the biotechnology industry, which presents unique problems of “self-replicating” patented products such as seeds and DNA. See Brief of Biotechnology Industry Organization as Amicus Curiae in Support of Neither Party at 9–10. Alternately, the Licensing Executives Society views Quanta Computer as an opportunity to clarify general uncertainties about the exhaustion doctrine’s scope and the effect of purchaser notification on patent licensing rights. See Brief of the Licensing Executive Society, Inc. as Amicus Curiae in Support of Neither Party at 3.

The Supreme Court has not directly reviewed the doctrine of patent exhaustion since a 1942 case, United States v. Univis Lens Co. However, the Supreme Court has recently heard several patent cases, including eBay Inc. v. MercExchange and KSR v. Teleflex in the last term. See Ming Shui, Supreme Court’s Recent Patent Decisions from the Perspective of a New IP Associate, The MTTLR Blog, Dec. 3, 2007. In these and other recent patent decisions, the Court has overturned Federal Circuit decisions favoring patent holders’ rights. See Court Agrees to Consider Patent Case on Royalties, New York Times, Sep. 26, 2007. With its decision in Quanta Computer, the Court may continue its trend of restricting patent holders’ rights.

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Analysis

I. Whether an Authorized Sale by a Patent Holder Exhausts Its Patent Rights Over the Sold Good

Quanta argues that an authorized sale of a product that embodies essential features of the patent exhausts the patent. Brief for Petitioners at 15. Quanta contends that it purchased microprocessors and chipsets from Intel, who was authorized by LGE through a license that imposed no conditions on selling and which stated that ordinary exhaustion principles would apply. See id. at 38–41. Quanta argues that these microprocessors and chipsets contain all of the essential and inventive features of LGE’s patent because all of the patented functions are carried out entirely within these components. See id. at 39–40. Furthermore, Quanta maintains that these products have no reasonable use that would not infringe LGE’s patents if LGE’s infringement claims were accepted. See id. at 39.

LGE argues, however, that a sale of a component of a patented system does not exhaust its rights in the system. See Brief for Respondent at 13. LGE maintains that the microprocessors and chipsets that Quanta purchased from Intel are different from the patented systems that Quanta claims authority to practice. See id. at 13. LGE explains that it granted Intel one license to manufacture and sell microprocessors and chipsets, and a second license to practice LGE’s systems and methods patents. See id. at 2. This agreement settled all potential infringement claims between LGE and Intel. See id. at 6. However, LGE argues, it required Intel to notify its customers that LGE’s license to practice the systems and methods patents did “not extend, expressly or by implication, to any product that [third parties] make by combining an Intel product with any non-Intel product.” See id. at 6, 9. Because of this express disclaimer, LGE argues, its rights in its systems and methods patents were not exhausted. See id. at 11.

Furthermore, LGE emphasizes, article and process patents are distinct. See Brief for Respondent at 51. LGE explains that patent rights in a tangible article can be exhausted because the remaining economic value of the patent is exhausted when the article is sold. See id. In a process patent, however, the economic value lies not in an article but in the means and use of the process. Thus, the patent holder’s rights continue to transfer and can never be exhausted through a sale, until stated otherwise in a contract or license. See id.

Quanta, however, argues that method claims can be subject to exhaustion if that method is practiced by the only reasonable use of the sold good. Brief for Petitioners at 35. Quanta contends that a patent may contain both apparatus and method claims covering the same invention, and that it is often difficult to separate the two in a process. If exhaustion only applies to apparatus claims, then sellers could destroy the exhaustion doctrine simply by including a method claim covering the intended use of the apparatus. See id. at 37–38. In addition, Quanta claims that there would be an “explosion” of infringement suits suing purchasers for a second round of royalties. See id. at 51.

In arguing that LGE has exhausted its patent rights, Quanta relies on the Court’s last case on exhaustion, United States v. Univis Lens Co., where the Court held that a patent holder who authorized its licensees to sell lens blanks could not impose price restrictions in its licenses. See Brief for Petitioners at 24. Quanta uses Univis to argue that once the patentee (here, LGE) sells his article and receives a royalty as consideration of his right, his monopoly in that article is exhausted and he cannot thereafter control the use or disposition of the article. See id. at 16, 24; 316 U.S. 241, 250 (1942). Allowing LGE to do otherwise, Quanta argues, would defeat the purpose of the exhaustion doctrine, which makes a valid sale and purchase of a patented machine the private individual property of the purchaser. See Brief for Petitioners at 13.

LGE contends, however, that Quanta misreads Univis. See Brief for Respondent at 26. LGE argues that in Univis, the lens blanks sold constituted the entire physical structure of the patented article and were not independent from the finished product. See id. Here, however, the components sold to Quanta do not constitute the entire physical structure of the systems, as the patented systems are practiced only when the components are combined with other devices. Consequently, LGE argues, the components do not embody essential features of the patented systems. See id. at 26–27.

Furthermore, LGE argues, Quanta’s proposed rule is an unnecessary expansion of the traditional exhaustion doctrine. See Brief for Respondent at 13–14. LGE notes that Congress has not included express statutory sections in the Patent Act providing for the general exhaustion of patent rights, even though it has had many opportunities to do so. LGE argues that this conveys the legislative intent to reinforce the discretion of patent holders to enforce their patent rights. See id. at 46. In addition, LGE argues that Quanta’s proposed rule does not further any legal or economic policies. Id. at 16. On the contrary, Quanta’s rule would require holders of combination patents to extract the full economic value of their rights from the first purchaser of any component of that combination, discouraging both innovation and cost allocations. See id. at 16–17.

Quanta, on the other hand, argues that Congress’ inaction for 150 years represents its acceptance of the Court’s precedents, which hold that when a patent holder sells its article whose sole value is in its use, he gives up the right to restrict that use. See Brief for Petitioners at 1, 15, 45. In addition, any change should come from Congress and not the courts, as Article I of the Constitution vests Congress with the right to make patent policy. Id. at 45. Furthermore, Quanta argues that the exhaustion principle makes good economic and policy sense because it minimizes transactions costs by forcing the patent owner to exact the full value of its patent rights in one negotiation with the first purchaser, who can then pass the burden down the distribution chain by charging a higher price. See id. at 15.

II. Whether Patent Holders Can Impose Restrictions on their Patented Goods

LGE argues that a patent holder may place restrictions on its licensees if the restrictions are reasonably related to the patent rights. Brief for Respondent at 39. LGE relies on Bement v. Nat’l Harrow Co. to argue that the Court will uphold conditions that are not illegal and agreed upon by the patentee and licensee. Id. at 42–43; 186 U.S. 70, 91 (1902). Furthermore, LGE contends that the unconditional sale of a patented article exhausts the patent rights only in that article, and does not extend beyond the particular article itself. Brief for Respondent at 19–20. LGE emphasizes that it seeks to enforce restrictions not on the sale or usage of the actual patented components, but on the making of the patented systems. See id. at 46.

While Quanta acknowledges that patentees can engage in conditional sales, it emphasizes that sellers cannot impose conditions subsequent to the transfer of title. Brief for Petitioners at 20. Quanta concedes that LGE required Intel to notify its purchasers that they did not have a license from LGE, but notes that LGE and Intel also agreed that a breach of this agreement would not affect Intel’s authority to sell. See id. at 41. More importantly, Quanta emphasizes that the district court correctly found that its purchase from Intel was in no way conditioned on its acceptance of Intel’s notice. See id.

In addition, Quanta argues, the question of the extent to which the use of the patented machine may validly be restricted is one for contract law, not patent law. See id. at 23. Quanta argues that if sellers want to impose restrictions on their goods, they should negotiate such restrictions through specific contracts with purchasers. See id. at 19. Quanta points out that LGE could have negotiated with Quanta directly, or authorized Intel to sell only to purchasers who had a prior license from LGE. See id. at 51.

LGE argues, however, that contract law is an insufficient substitute for the protections of patent law. Brief for Respondent at 33. LGE contends that it is unreasonable to expect a patent holder to ascertain the full value of its invention and all of the purchasers and uses to which the article would be put. See id. at 33. Moreover, LGE maintains, a breach would entitle patent holders to monetary damages but not necessarily to injunctive relief, consequently allowing the breaching party to continue to sell infringing items. Id. at 34.

Furthermore, LGE contends that the sale could have at most given rise to an implied license. Id at 35. However, LGE argues that the lower courts were correct in finding that because of the express disclaimer, there was no implied license authorizing Quanta to practice LGE’s systems and methods patents. See id. at 11. Furthermore, even if a license could be implied, it would be limited to allowing Quanta to practice the patents with only Intel parts. See id.

Quanta, however, argues that exhaustion is not an implied license that can be repudiated by the patentee. Brief for Petitioners at 25. While the doctrine of implied license is one of quasi-contract, depending on the parties’ reasonable beliefs as to how the product will be used, the separate doctrine of patent exhaustion differs as it arises from inherent limits on the grant of the patent right. Id. at 25–26. Quanta argues that the doctrine of patent exhaustion applies here, and that because LGE’s patent rights were exhausted when it sold the patented product, Quanta does not need any license, express or implied, to use the product. See id. at 13.

Moreover, Quanta argues that the exhaustion doctrine is critical in maintaining the boundaries between patent monopoly and antitrust principles, as a restriction within the patent monopoly is inherently immune from antitrust scrutiny. See id. at 50. Quanta argues that the Court should reverse the Federal Circuit’s holding and preserve the exhaustion doctrine in order to ensure that patent owners are not completely immunized from antitrust violations. See id. at 50.

LGE, on the other hand, argues that the Court does not need to follow Quanta’s proposed rule in order to guard against anti-competitive conduct. See Brief for Respondent at 17. LGE emphasizes that it is only arguing that patent holders have the right to place reasonable restrictions on the licensing of their patented inventions, not that they have an unlimited right to impose conditions on patented articles. See id. at 48. While some restrictions could stifle (or favor) competition, LGE argues that the mere possibility of anti-competitive effects cannot justify a per se rule that limits patent rights more than other property interests. Id. at 48.

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Conclusion

The Supreme Court’s decision in Quanta Computers may determine whether LGE’s agreement with Intel, and Intel’s subsequent sale to Quanta, exhausted LGE’s patent rights in its devices, methods, and processes. A decision for Quanta holding that LGE’s rights were exhausted would limit patent holders’ rights in their patents, potentially lowering the value of patents and reducing incentives for innovation. A decision for LGE, upholding the Federal Circuit, would expand patent holders’ rights by allowing patent holders to sue downstream purchasers for infringements on their patents. Either way, the Supreme Court’s decision in this case will clarify the scope of the doctrine of patent exhaustion and the circumstances under which patent holders can sue purchasers of its patented devices for infringement.

Authors

Prepared by: Hana Bae and Courtney Zanocco

Edited by: Heidi Guetschow

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