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Quanta v. LG: Method claims can be exhausted; harder to assert infringement later in distribution
June 09, 2008

The Supreme Court today decided Quanta Computer, Inc. v. LG Electronics, Inc., dealing with the doctrine of patent exhaustion (also called the first sale doctrine). In a nutshell, the Court made it more difficult for patent holders to maintain a claim for infringement down the distribution chain of a product. There were three main aspects to the decision:

  1. Method claims, like product claims, are subject to exhaustion
  2. Sale of a product whose only reasonable and intended use is to practice the patent and that "substantially embodies" the essential features of the patented method can trigger exhaustion
  3. In order for a downstream sale to constitute an infringement, it must be outside the scope of the original license

More detail of these aspects of the holding and additional thoughts below the fold.

The case involves three patents owned by LG Electronics relating to the interaction of computer components. The patents at issue include:

  • 4,939,641 (claiming, in relevant part, a system for ensuring that outdated data is not retrieved from memory)
  • 5,077,733 (claiming, in relevant part, a method that controls the access of a device to a bus shared by multiple devices)
  • 5,379,379 (claiming a system and method for ensuring that outdated data is not retrieved from memory)

LG licensed the patents to Intel, who produced microprocessors and chipsets that were capable of practicing the claimed inventions, although the methods are not actually practiced until the computers are fully assembled. LG's license agreement with Intel authorized Intel to "make use, sell (directly or indirectly), offer to sell, import or otherwise dispose of" Intel products practicing LG's patents, however the license stated that no license was granted "to any third party for the combination by a third party of Licensed Products of either party with items, components, or the like acquired . . . from sources other than a party hereto, or for the use, import, offer for sale or sale of such combination." Accordingly, the license purported to be restricted to products where no non-Intel products were incorporated with the licensed (Intel) products. By way of a separate agreement, Intel was required to notify its customers of this restriction, but also noted that "a breach of this Agreement shall have no effect on and shall not be grounds for termination of the Patent License."

Quanta (and other manufacturers also named in the suit) purchased Intel chipsets, were notified of the restricted nature of the license, but nevertheless combined the Intel chipsets with non-Intel products in violation of the restriction. As a result of this behavior, LG sued. Quanta defended on the basis that because the sale of the chipsets from Intel was authorized under the terms of LG's license with Intel, LG's patent rights were exhausted, and there could be no infringement. The district court and Federal Circuit held that there was no exhaustion for two reasons. First, method claims were not subject to exhaustion by the sale of a product, and second, the sales were outside the scope of Intel's license, and therefore did not exhaust LG's rights. The Supreme Court granted certiorari, and reversed.

Method claims are subject to exhaustion

The Supreme Court rejected the notion that method claims could not be exhausted by the sale of a product. The Court traced the history of patent exhaustion back to the 19th century, and noted that with rare exceptions, its cases have rejected attempts by patentees to place post-sale restrictions on the use of a patented product. For example, in United States v. Univis Lens Co., the Court held:

[W]here one has sold an uncompleted article which, because it embodies essential features of his patented invention, is within the protection of his patent, and has destined the article to be finished by the purchaser in conformity to the patent, he has sold his invention so far as it is or may be embodied in that particular article.

Tracing this lineage of exhaustion, the Court saw no reason to carve out an exception for method claims: "It is true that a patented method may not be sold in the same way as an article or device, but methods nonetheless may be 'embodied' in a product, the sale of which exhausts patent rights." The Court was concerned that applicants would include method claims in their patent applications for the simple purpose of avoiding exhaustion: "By characterizing their claims as method instead of apparatus claims, or including a method claim for the machine's patented method of performing its task, a patent drafter could shield practically any patented item from exhaustion."

The product sold must "substantially embody" the method claim to trigger exhaustion

Having held method claims can be subject to exhaustion, the next question was when sale of a product is sufficient to trigger exhaustion. Analogizing the Univis case, the Court held exhaustion is triggered when the product sold (1) "is capable of use only in practicing the patent," and (2) "embodies essential features of the patented invention." In this case, there was no real dispute that the Intel products sold met these two requirements. The chipsets and microprocessors were specifically designed to practice the claimed methods, and all that was required for them to do so was to be connected to standard computer equipment in a standard way. The court also noted that sale of the same product may exhaust multiple patents, for example if the product practices one patent while substantially embodying a second patent. As a result, assuming the original sale by Intel was within the scope of the license, exhaustion applied.

If the sale of a product is within the terms of a license, exhaustion applies

The final question was whether the sale of the products from Intel to Quanta was authorized by LG, and therefore operated to exhaust LG's patent rights. LG argued there was no authorized sale because the terms of the license did not permit Intel to sell its products for use in combination with non-Intel components to practice the patents. As a result, according to LG, "Intel could not convey to Quanta what both knew it was not authorized to sell, i.e., the right to practice the patents with non-Intel parts."

The Court rejected this argument based on the structure of the agreements between LG and Intel. As described by the Court (internal citations omitted):

Nothing in the License Agreement restricts Intel's right to sell its microprocessors and chipsets to purchasers who intend to combine them with non-Intel parts. It broadly permits Intel to "'make, use, [or] sell'" products free of LGE's patent claims. To be sure, LGE did require Intel to give notice to its customers, including Quanta, that LGE had not licensed those customers to practice its patents. But neither party contends that Intel breached the agreement in that respect. In any event, the provision requiring notice to Quanta appeared only in the Master Agreement, and LGE does not suggest that a breach of that agreement would constitute a breach of the License Agreement. Hence, Intel's authority to sell its products embodying the LGE Patents was not conditioned on the notice or on Quanta's decision to abide by LGE's directions in that notice.

The end result was that Intel's sale to Quanta was within the scope of the license, notwithstanding the apparent restriction in both the agreement between Intel and LG as well as the notice about the limitations on the license provided by Intel to Quanta. As a result, LG's patent rights were exhausted by this sale, and LG could not pursue its patent infringement claims against LG.

This begs the question: what, if any, remedies does LG have? The Court, in a footnote, stated it expressed no opinion regarding possible breach of contract damages, observing they were not alleged in the complaint. However, it's less than clear against whom they might have a remedy. Based on the Court's description, Intel appears to be in compliance with the terms of its agreements with LG. It's not clear whether an actual contract was entered into between LG and Quanta as a result of the "notice" provision in the Intel license, so it's possible that LG does not have a contractual remedy against either part here.

Patentees are now faced with the question of how to deal with the ramifications of the Court's holding. What is clear is that patentees will attempt to find creative ways to avoid the result in this case, and there may be a host of situations where parties attempted to restrict use of their patents, but those restrictions are now mooted because of the exhaustion.

To read the full decision in Quanta Comp., Inc. v. LG Elecs., Inc., click here.

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