The Supreme Court walked up to the edge, but left first sale and exhaustion doctrine intact.
The Supreme Court in Quanta Computer, Inc. v. LG Electronics, Inc., 2008 WL 2329719, 86 USPQ2d 1673 (US 2008) confirmed both the importance of patent exhaustion as a doctrine and the appropriate limitations of that doctrine – the doctrine does not apply to transactions that are conditional in nature. That means, simply, that the terms of a contract determine when or if exhaustion or first sale occurs. That is how it should be.
But the limits must be part of a contract. Mere notices or warnings do not suffice.
Quanta involved an arrangement in which LG licensed Intel to sell products that largely encompassed LS method and other patents. A “Master Agreement” required Intel to give notice to buyers that this sale did not grant a license to use the items with products of third party manufacturers. The issue was whether the method patent claims embodied in this license agreement were exhausted by Intel’s sale of product to third parties. The Court held that exhaustion occurred.
There were two primary issues. First, does the doctrine of exhaustion apply to “method patents.” The Court said yes, if the product was sold in an authorized sale. That is a correct ruling. To hold otherwise, would create artificial barriers and distinction. According to the court, the doctrine now applies whenever the item sold embodies a sufficient amount of the claims method patent. On what is sufficient, the Court reverted to earlier authority commenting that exhaustion is triggered by a sale if the sold items’ only reasonable and intended use is to practice the patent and they “embodie[d] essential features of [the] patented invention.” This was met in Quanta.
That was the easy issue.
The more at risk issue was whether the sales by Intel pursuant to its license triggered the exhaustion doctrine. The Court could have gone off the deep end here and eviscerated distribution methods used in software and many other industries. But it did not. Instead, the Court emphasized that exhaustion (first sale) occurs only if there was an authorized and unconditional sale of a product. This is the right rule – first sale is not a right of the purchaser or an absolute mandate in law, but simply a consequence of a marketing decision by the rights owner. It arises only if the rights owner authorizes unconditional sales of copies.
Having gotten that part right, the Court then held that the Intel-LG arrangement authorized unconditional sales. The key to this conclusion was that the license to Intel authorized sales and that the Master Agreement merely required Intel to give notice to buyers that the sale did not create an implied license to use the product with non-licensed other products. This did not condition the authority to sell or the terms of the sale. Bad drafting of the arrangement perhaps.
The sales of product were unconditional. But what of the notice? It merely blocked any implied license argument, but did not become a limiting part of the contract with the buyer, or a condition on Intel’s right to make an authorized sale. But, the buyer’s defense did not lie in an implied license. It was based on exhaustion of the patent by an unconditional sale.
The distinction here lies in the nature of the sale authorized by the license. If the transaction between Intel and LG had restricted Intel’s right to sell products to cases in which the sale was conditional on the buyer agreeing to not use the product in a third party configuration, then exhaustion would not apply. Here, the agreements, as viewed by the Court, authorized unconditional sales and merely required a notice relating to the absence of any implied license.