THE SUPREME COURT SHOOTS DOWN THE CAFC – AGAIN

04.07.2017

By Lawrence Hoffman

In our January Happenings post (http://www.ipatent.co.il/ip-happenings-december-2016-january-2017/) we reported the U.S. Supreme Court agreed to review the decision of the U.S. Court of Appeals for the Federal Circuit (CAFC) in the case of Impression Products, Inc. v. Lexmark International, Inc. Oral Argument was held on 21 March 2017 and as we reported in our March Happenings post (http://www.ipatent.co.il/ip-happenings-march-2017-2/), the argument transcript did not give much from which to predict how the court would rule.

Well, now we know: on May 30, the Court issued its decision. And as is often the case, the CAFC was wrong again.

The Facts:

Reviewing the facts briefly, Lexmark sells printers and toner cartridges for its printers. Lexmark owns patents that cover its cartridges and their use. The cartridges can readily be refilled and reused by third parties, but that obviously cuts into Lexmark’s sale of replacement cartridges. To counter this, Lexmark sells it cartridges either at a full list price with no restriction as to reuse, or at a discount as part of a “Return Program”. For the Return Program cartridges, the buyer must sign a contract agreeing to use the cartridge only once and to refrain from transferring the cartridge to anyone but Lexmark.

To enforce the single use restriction, Lexmark installs microchips in its Return Program cartridges that indicate when the cartridge is empty. The printer recognizes this and does not allow reuse of refilled cartridges. That’s a good idea in theory, but enterprising third parties have reverse engineered the Lexmark microchips and have created replacement microchips that fool the printer into allowing reuse.

Impression acquires cartridges containing the replacement microchips, refills them and resells them in the United States at prices that undercut Lexmark’s prices.  Some of these cartridges were originally first sold in the U.S. while others were first sold elsewhere.

Lexmark brought an action for patent infringement against Impression. As to the Return Program cartridges originally sold in the U.S. (the “U.S. cartridges”), it argued that the reuse was not authorized and therefore constituted infringement under § 271 of the Patent Act. As to the cartridges originally sold outside the U.S., (the “other cartridges”)Lexmark’s position that the original sale was not subject to U.S. patent law and that their sale in the U.S. infringed its patents just as new cartridges  manufactured by a third party would infringe.

Impression moved to dismiss as to all the cartridges it sold, irrespective of its place of original sale. The district court agreed with Impression as to the U.S. cartridges on the basis that the initial sale by Lexmark in the U.S. effectively exhausted its U.S. patent rights and that the resale/reuse restriction was not enforceable under patent law. As to the other cartridges, however, the district court agreed with Lexmark and denied Impression’s motion to dismiss.

On appeal, the CAFC reversed as to the U.S. cartridges and affirmed as to the other cartridges. The court relied on its own precedent and distinguished two arguably contrary recent Supreme Court decisions, one involving copyright law (Kirtsaeng v. John Wiley & Sons, Inc.,) and the other involving a patent license (Quanta Computer, Inc. v. LG Electronics, Inc.). Both of these are discussed below.

The Court’s Decision:

At issue before the Supreme Court was the effect of the first sale or exhaustion doctrine as applied to the U.S. Return Program cartridges and to all the other cartridges. In its decision, the Court held unanimously that the exhaustion doctrine barred use of patent law to enforce the no reuse restriction on the U.S. cartridges and with respect to all the other cartridges as well. As to the other cartridges, the Court also held that exhaustion applies, with only Justice Ginsberg dissenting.

With respect to the U.S. cartridges, the Court cited precedent extending back more than 160 years to the effect that an authorized sale of a patented item automatically terminates rights to that product derived from patent law. Citing its 1942 decision in  United States v. Univis Lens Co., the court stated, “[A] patentee is free to set the price and  negotiate contracts with purchasers, but may not, by virtue of his patent, control  use or disposition” of the product after ownership passes to the purchaser. In other words, a legally valid contract, e.g., valid under antitrust law could be enforced by an action for breach of contract, but not by an action for patent infringement.

The Court’s spoke most recently on exhaustion in its 2008 decision in Quanta Computer, Inc. v. LG Electronics, Inc., which, in the Court’s words, “settled the matter”. Here, LG licensed Intel to sell patented microprocessors but only under contracts requiring purchasers to use them with other parts manufactured by Intel. Quanta, an Intel customer, disregarded the restriction, and LG sued for patent infringement. As the Court said here, “[W]ithout so much as mentioning the  lawfulness of the contract, we held that the patentee could not bring an infringement suit because the “authorized sale . . . took its products outside the scope of the  Patent monopoly.”

The Court thus ruled as to the U.S. cartridges that:

Lexmark cannot bring a patent infringement suit against Impression Products to enforce the single-use/no-resale provision accompanying its Return Program cartridges. Once sold, the Return Program cartridges passed outside of the patent monopoly, and whatever rights Lexmark retained are a matter of the contracts with its purchasers, not the patent law.

 

In analyzing the CAFC decision, the Court noted that it incorrectly treated exhaustion as an interpretation of ” the infringement statute. It therefore concluded while exhaustion “reflects a default rule, a patentee does not have to hand over the full “bundle of rights” with every sale. CAFC failed to realize that the exhaustion doctrine derives from the common law prohibition against restraints on alienation and is thus a limit on “the scope of the patentee’s right” to restrain alienation by excluding others from their inherent right to make, use, and sell, etc. The authorized sale terminates that power.

The CAFC reasoned that a blanket imposition of exhaustion would create an unjustified distinction between sales by the patentee and sales by licensees. The Court dismissed this concern, saying that a patent owner can impose restrictions on licensees because a license is not a sale, but a modification of the contours of the patent monopoly. Failure of licensee to comply with a license restriction when selling an item may give rise to an action for infringement against the licensee, but sales in compliance with the license are treated, for purposes of patent exhaustion, as if the patentee made the sale itself and exhausts the patentee’s rights under patent law. If a purchaser does not comply with a properly communicated restriction, the licensee has done no wrong. The licensee can sue for breach of contract, just as the patent owner could if it had sold the item with a restriction.

The Court then turned to the importation of the other cartridges. Again, the Court focused on origin of the exhaustion doctrine, i.e., “the common law’s refusal to permit restraints on the alienation of chattels” and noted that “[T]he common-law doctrine makes no geographical distinctions.”

The Court then discussed its 2013 decision in Kirtsaeng. This was a copyright case arising out of the purchase outside the U.S. of textbooks at a price lower than that in the U.S. for resale in the U.S. at an intermediate price. Court noted that § 109(a) of the copyright act provides, in pertinent part:

. . . the owner of a particular copy . . . lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy . . .

Finding nothing in the text to distinguish between domestic and international sales, it interpreted the text according to the common law origin, “a straightforward application” of the first sale doctrine required the conclusion that it applies overseas”.

Applying patent exhaustion to foreign sales, it ruled:

. . . is just as straightforward. Patent exhaustion, too, has its roots in the antipathy toward restraints on alienation, and nothing in the text or history of the Patent Act shows that Congress intended to confine that borderless common law principle to domestic sales. In fact, Congress has not altered patent exhaustion at all; it remains an unwritten limit on the scope of the patentee’s monopoly.

Differentiating the patent exhaustion and copyright first sale doctrines, the Court  said:

would make little theoretical or practical sense: The two share a “strong similarity . . . and identity of purpose . . . and many everyday products—“automobiles, microwaves, calculators, mobile phones, tablets, and personal computers”—are subject to both patent and copyright protections . . . There is a historic kinship between patent law and copyright law, and the bond between the two leaves no room for a rift on the question of international exhaustion.

Lexmark argued that exhaustion should not affect sales outside the U.S. because such sales are not subject to the exclusionary rights granted under U.S. patent law. Without those rights, a patentee selling in a foreign market may not be able to sell its product for the same price that it could in the United States, and therefore is not sure to be compensated in the way contemplated by U. S. patent law.

The Court rejected this argument finding no basis for distinguishing copyright protections as those also had no extraterritorial operation. It emphasized that;

Exhaustion is a separate limit on the patent grant, and does not depend on the patentee receiving some undefined premium for selling the right to access the American market. A purchaser buys an item, not patent rights. And exhaustion is triggered by the patentee’s decision to give that item up and receive whatever fee it decides is appropriate for the article and the invention which it embodies. (Internal quotes and citation omitted.)

The Court noted that it had addressed international patent exhaustion only once in Boesch v. Gräff over 125 years ago. But that case dealt with a situation in which the foreign sale was by a third party, not one authorized by the owner of the U.S. patent. In that situation, the sale abroad did not exhaust the patent owner’s rights with respect to subsequent importation of the item.

Finally, it may be noted that the Court had requested the views of the U.S. Government, which took the position that “a foreign sale authorized by the U. S. patentee exhausts U. S. patent rights unless those rights are expressly reserved.” The Court rejected this as “largely based on policy rather than [on legal] principle” and found no legitimate precedential  support (and certainly no statutory support) for this approach.

Reactions in the Blogoshpere:

The ink is barely dry on the slip opinion, but given the significance of the decision, many of the usual suspects have already weighed in. You can read some of these here, here, and here, but in sum, the reactions have been largely passive as to the ruling on the U.S. cartridges, but quite negative as to exhaustion relative to the other cartridges. Those with connections to Pharma view the decision with dismay as they see it opening the floodgates to low priced imports of patented drugs sold abroad. However, there are other drug import regulations and what is likely to be a growing uprising against the high cost of medical products in the U.S. that will probably drown out the effects of this decision in the Pharma industry.

Others speculate as to the uncertainties the decision will create in foreign markets, e.g., whether renegotiation of trade agreements might nullify the effect of the decision and how existing contracts might have to be revised. There were also speculations that U.S. patent owners might raise their prices for sales outside the U.S. (e.g., “life-saving pharmaceuticals”) to nullify any price differential.

Some comments struck me as a bit silly, e.g.,  that the Court essentially held that patent rights cannot be used to enforce contracts.  What the Court really said was that if exhaustion prevents assertion of patent rights, look to the law of contracts. But realistically, the contract law may be of little practical help. In the present case, the only parties with whom Lexmark had a contractual relationship were its suppliers and end users. Aside from the fact that manufacturers  don’t like to sue their customers there is little economic justification for such action.

Another questionable observation characterize the decision as “extending U.S. patent law to foreign transactions that have nothing to do with the United States”. That, too, misses the point. The decision does just the opposite: all it says is that would-be importers  will not be subject to U.S. patent laws.  Yes, existing contracts between patentees and foreign distributors may need to be renegotiated but lawyers are surely clever enough to draft contracts that will provide patent owners with reasonable, if more limited, control of the distribution of their products.

A final observation suggested that Lexmark might drop its Return Program. That’s certainly a possibility, but that is something the economic gurus at Lexmark will need to decide. Or they might just be spiteful and disregard environmental considerations by making their cartridges non-refillable.  Which raises an interesting point: might some green-leaning Congress enact incentives for making more kinds of products reusable?

All these speculations aside, it’s way too early to judge the effect of this decision. But unless Congress gets into the act, business and lawyers will just have to muddle on.

About the author: Larry Hoffman has a B.S. in Electrical Engineering and Comp. Sci. from Massachusetts. Institute of Technology and a J.D. from the George Washington University School of Law. He has been a lawyer since 1965 specializing in IP law and product liability defense. He is registered to practice before the U.S. PTO, the U.S. Court of Appeals for the Federal Circuit and the state and federal courts in New York, Maryland, and the District of Columbia. His work has included preparation and prosecution of patents in countries throughout the world, and counseling on IP and product safety matters. He has been involved in the trial of close to 100 lawsuits of various kinds. You can reach him at Lawrence@ipatent.co.il.

 

 

 

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