Hovey Williams, LLP

Protecting Patent Rights from Exhaustion: Supreme Court Decides Quanta v. LG

By Brandon J. Warner

Hovey Williams has always stressed the importance of well-drafted license agreements, especially in view of the doctrine of patent exhaustion.  The United States Supreme Court’s recent ruling in Quanta Computers, Inc. v. LG Electronics, Inc. reinforces the significance of protecting patent rights through contract law. 

The grant of a U.S. patent provides a patentee with exclusive rights to prevent others from making, using, selling, offering to sell, or importing patented inventions, but the doctrine of patent exhaustion extinguishes those rights after the first unconditional sale of a patented product.  Thus, while a well-drafted patent application is essential to ensure the broadest protection for a patented product from the outset, a well-written contract or license agreement is critical to adequately protect the patentee’s exclusive rights in the marketplace.

On June 9, 2008, the Supreme Court issued its opinion in Quanta, which highlighted the interplay between patent rights, contract language, and the exhaustion doctrine.  The full text of the opinion can be read here.

The Underlying Dispute

LG acquired various patents relating to methods of increasing the efficiency of a computer’s memory system and licensed these patents to Intel for use in assembling microprocessors and other computer chipsets.  While the license agreement did include provisions attempting to limit rights of third parties, of crucial importance is the fact that the contract broadly authorized Intel to make, use, sell (directly or indirectly), offer to sell, import, or otherwise dispose of Intel products practicing LG’s patented methods.  There was a separate agreement between Intel and LG that the Intel components, which practiced the LG patents, were not to be used with non-Intel products.  As authorized by the agreement, Intel assembled products (computer chips), which it then sold to Quanta and other computer manufacturers.  Quanta, however, subsequently combined the Intel chips with non-Intel components to assemble a computer, an action specifically not authorized by the agreement.

LG sued Quanta and other similarly-situated computer manufacturers, claiming the combination of the Intel chips with the non-Intel components (standard buses and memory) infringed its patents.

The district court granted summary judgment in favor of Quanta based, in part, on its finding that LG’s patent rights were exhausted when LG authorized Intel to make and sell its microprocessors and chipsets that practiced the LG method patents.  LG appealed and the Federal Circuit reversed, holding that method patents were categorically exempt from the doctrine of patent exhaustion.  The appellate court also held that a notification sent by Intel to Quanta, regarding the condition that the Intel components that practiced the patented method were not to be used with non-Intel products, sufficiently protected LG’s patent rights from exhaustion.

The Supreme Court Speaks

In a unanimous opinion, the Supreme Court reversed the Federal Circuit, holding that LG’s patent rights in the Intel products were exhausted when Intel sold its products to the computer manufacturers.  The Court’s decision was based on three conclusions:

1. All patents, including method patents, are subject to the exhaustion doctrine.  The Court explained that method patents – like apparatus or product patents – are exhausted by the unconditional sale of an item that embodies the particular method.  The Federal Circuit’s exemption of method patents from exhaustion would “seriously undermine” the doctrine, as patent attorneys could draft method claims instead of apparatus claims to avoid the consequences of exhaustion.  Also, exempting method claims from exhaustion would place later purchasers of products (such as Quanta) at risk for costly patent litigation.
2. A patentee’s right to control the use of a patented product ends when the patentee authorizes an unconditional sale of an item that “substantially embodies” the patent.  In the case of a method patent, if a particular product only has utility in practicing the claimed method – such as a system for processing memory in a computer chip – then an unrestricted sale of that product equates to an unrestricted sale of the method.  Even if the product itself does not completely embody the patented method, the sale of that product will exhaust the patent if the only remaining step to practice the patented method is the application of common processes or the addition of standard parts.
3. LG’s unconditional license agreement with Intel failed to protect its patent rights from exhaustion when Intel sold its products to Quanta.  LG’s patents could only be used when they were practiced by a microprocessor or memory chip, and these products could only run the patented processes if they were included in a computer.  Thus, the Intel products substantially embodied LG’s method patents.  Because LG’s license agreement with Intel did not limit Intel’s ability to sell the Intel products, the Court held that the agreement functionally authorized an unconditional sale of the LG patents.  The sale of these products to Quanta therefore exhausted LG’s patent rights in spite of a separate notification requirement.

Lessons Learned

The Supreme Court’s decision in Quanta underscores the crucial role of license agreements and other contracts in protecting a patentee’s rights.  Patentees should work closely with their patent counsel to create reasonable conditions on the sale of their products or systems in the marketplace.  Drafting too broad of an agreement, for example, may result in the unintentional exhaustion, or loss, of patent rights, as was LG’s fate in this case.

The opinion makes clear that method patents are not categorically excluded from the doctrine of patent exhaustion, but other aspects remain murky, such as what exactly is required for a product to “embody” a method.  While the Court provided some guidance regarding when the sale of an incomplete product can exhaust patent rights, as a practical matter, this will likely be difficult to apply in many situations.  Whether or not a particular product “substantially embodies” the invention is expected to be the subject of future litigation.

Furthermore, the Court did not specifically address issues of conditional sales and limited licenses, indicating that such provisions may remain enforceable.  Thus, even after Quanta, some types of contractual restrictions (e.g., a limitation on a licensee’s ability to make an authorized sale) may still be viable avenues for avoiding inadvertent exhaustion of patent rights and facilitating breach of contract claims.  It is important for patentees to work closely with their patent attorneys to determine how this opinion may affect their licensing strategy.

Brandon J. Warner is an associate at Hovey Williams.  You can contact Brandon at .(JavaScript must be enabled to view this email address).

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