June 10, 2008Client Alert

The Supreme Court Clarifies The Patent Exhaustion Doctrine

A ruling by the Supreme Court today weakened the ability of patent owners to control the use of a product that embodies a patented method after the sale of that product. The Court held that the authorized sale of an article that substantially embodies a patented method exhausts the patent owner's rights and prevents the owner from using patent laws to control post-sale use of the article.

In Quanta v. LG Electronics, 553 U.S. __ (June 9, 2008), LGE owned patented technology for efficiently managing data flow on a bus (wires) connecting computer components. LGE licensed Intel the right to make and sell microprocessors and chipsets using this patented technology, but the agreement stipulated that no license was granted to third parties for the combination of the Licensed Products with non-Intel components acquired from sources other than LGE or Intel. Intel manufactured products that "substantially embodied," but did not "completely practice," the patented invention such that "its only and intended use is to be finished under the terms of the patent." A separate agreement ("Master Agreement") required that Intel provide written notice to its customers that Intel's license does not cover products that combined the purchased Intel product with non-Intel parts.

Intel, with proper written notice, sold the products to Quanta and other computer manufacturers who subsequently incorporated the products into computers containing non-Intel parts. LGE sued the computer manufacturers claiming the combination infringed its patents. The Federal Circuit affirmed the lower court's holding that the patent exhaustion doctrine did not apply to method claims, but also held that the exhaustion doctrine did not apply because LGE did not grant Intel the right to sell the products to the computer manufacturers.

The Supreme Court held the patent exhaustion doctrine, by which the initial authorized sale of a patented product exhausts all patent rights in the item, applies to method claims. Even though a patented method is not sold in the same manner as a product, methods may be essentially "embodied" in a product such that its sale exhausts all patent rights. The Court further determined that an authorized sale of components of a patented system that must be combined with additional parts in order to practice the patented methods exhausts the rights held by the patent where the component embodies the patented invention's essential features. Otherwise, the patent exhaustion doctrine could be circumvented by merely drafting method claims, rather than product claims.

A product "embodies" a patented method if such product "embod[ies] essential features of the patented invention." This finding is strengthened when there is "no reasonable use" for the product but for incorporating it with another product that practices the claimed invention, and if the sold product constitutes "a material part" of the patented invention and "all but completely practice[s] the patent."

However, the patent exhaustion doctrine is triggered only when the sale is authorized by the patent holder. If such an authorized sale occurs, the purchaser's right to practice the patented invention resides in the doctrine of patent exhaustion, not implied license.

Clients that license technology may wish to review existing license agreements in view of the Court's decision, and the decision raises a number of considerations in drafting new licenses. First, a licensor may be able to avoid the patent exhaustion doctrine, and the pitfalls of LGE's license, by carefully drafting into the agreement provisions that restrict the licensee's right to sell components that embody essential features of the patented invention to third parties. This precautionary step may be particularly critical if the product embodying the claimed method has no use other than to be combined with another product to carry out the claimed method, or if the product constitutes "a material part" of the patented invention and "all but completely practice[s] the patent." Second, the decision does not by its terms strike license agreements whereby the licensee is prohibited from practicing the invention in certain fields of use. Third, use of formal sublicensing arrangements might permit control of the patent rights downstream of the licensee.
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