The recent U.S. Supreme Court decision in Quanta Computer, Inc. v. LG Electronics, Inc., limits the ability of patent owners to demand downstream royalties from customers of their licensees, or other downstream purchasers.
This decision, as did a string of recent Supreme Court decisions, further restricts the rights of patent owners.
The dispute arose in the economically significant microprocessor/computer market. LGE and Intel had a cross-license that allowed Intel to manufacture and sell Intel’s microprocessors. The license agreement, however, granted no license under LGE patents to Intel’s customers to combine the microprocessors with non-Intel components. Further, another agreement required Intel to give notice to its customers that they received no such license.
Intel sold its microprocessors to Quanta and other computer manufacturers. Those manufacturers then incorporated the microprocessors into their computers. LGE sued Quanta, demanding royalties for patent infringement, because using the Intel microprocessors in the Quanta computers practiced the LGE patents without a license.
The patent statute would normally give LGE the right to preclude others, such as Quanta, from practicing LGE’s patented inventions. The Supreme Court, however, had long ago held that an unconditional sale of a patented article by a patent owner (or by its licensee) abandoned or “exhausted” all of the patent owner’s patent rights to that article.
Under the exhaustion doctrine, after an initial sale, patent law did not prevent the purchaser of the article from using or reselling the article as the purchaser pleased. The court had adopted this doctrine to prevent a patent owner from recovering twice for the same article, and to eliminate the burden of downstream patent restrictions on licensed products.
Since LGE had licensed Intel, Quanta asked the court to rule that the sale by Intel terminated LGE’s patent rights so that Quanta did not need its own license to use the Intel products.
The court agreed and ruled in favor of Quanta.

Expanded ‘exhaustion’ doctrine

The court expanded the exhaustion doctrine in two ways to further limit the ability of patent holders to exercise control after an initial sale or license.
First, LGE had prevailed in the lower court in part because some of its patents did not cover the microprocessors themselves, but rather a method (or process) of using the microprocessors. Many inventions, such as computer programs, can be patented either as articles (“a computer program that performs operations A, B, and C”) or as methods (“a method including performing operations A, B, and C”)).
The lower court ruled the exhaustion doctrine applied only to patents for articles, not to patents for methods. But the Supreme Court overruled the lower court, expanding the doctrine to cover method patent claims as well as article claims.
The court ruled that LGE cannot prevent purchasers of Intel microprocessors from making patented use of the microprocessors since Intel, the manufacturer, itself had a license for those microprocessors.
Second, the decision also clarified that a sale can exhaust patent rights even though the sale was of something less than the entire invention.
LGE patented the use in a computer of a certain novel program embedded on a microprocessor. Since Intel sold only the microprocessor and not the computer, LGE argued that technically the sale did not exhaust its patent rights in the computer itself.
As the court explained, however, exhaustion applies if the item sold “sufficiently embodies” the patent, even if it does not completely practice the patent. The court gave an example of where exhaustion would apply, namely, where “the only reasonable and intended use” of the item (here, a microprocessor) was to practice the patent (here, use the microprocessor in a computer), and the item “embodied the essential features” of the invention.
The court found that the Intel products embody everything inventive about each patent. Quanta was not required to make any creative or inventive decision when it added uses or a memory. Intel’s sale of the programmed microprocessor exhausted LGE’s patent rights, even though the microprocessor had to be connected to those parts in order to practice the entire invention.

Substantial impact

This decision could have a substantial impact in industries such as the electronics and computer industries, where the largest companies, with hundreds, if not thousands, of patents, regularly cross license each other’s portfolios to avoid internecine patent litigation. Under this decision, the cross licenses could immunize one company’s customers from most patent suits that the cross licensors could otherwise bring.
Patent owners will have to find ways to minimize its impact. In particular, the decision does not prevent the use of contractual clauses or remedies to preserve or to replicate a patent owner’s options.
The decision explicitly approves the court’s earlier General Talking Pictures decisions in which it allowed field-of-use restrictions for patent licenses. The court will not likely find a sale exhausting patent rights when a license agreement allows the licensee to sell only to certain purchasers.
In Quanta, by contrast, although Intel had agreed to notify its customers that LGE had not licensed certain uses, the agreement allowed Intel to make sales to customers, regardless of the customer’s intended use. At a minimum, the decision would appear to limit the enforceability of restrictions under the patent statute against third parties to only those restrictions the agreement also imposes on the licensee in selling to third parties. Following Quanta, a patent owner will likely have to depend completely on its single initial transaction, whether sale or license, for whatever compensation the patent owner hoped to receive under the patent, rather than attempt to extract an additional royalty from a downstream purchaser.
In reaching its decision, the court rejected arguments made by various industry groups that the court should adopt a rule permitting a patent owner, with adequate notice, to require separate licenses at various stages. This would have created market efficiencies that would allow for a more compartmentalized exploitation of intellectual property rights.
Although Quanta would seem to rule that a license would exhaust the patent owner’s patent rights, the license agreement could create a contractual (as opposed to statutory) obligation on the licensee to pay a royalty on its customers’ uses of a product. A patent owner can draft its license agreement to make its licensee financially responsible for any downstream use by the licensee’s customers.
Although such contractual clauses could blunt the impact of this decision, persuading a licensee to agree to such clauses might present an insuperable problem, particularly where the clauses would substantially burden the licensee. In this case, for instance, Intel clearly would not have entered into any such agreement.
Subsequent cases may present varying circumstances where lower courts will not rigorously apply the exhaustion doctrine. For instance, the Supreme Court appeared to except from its ruling that an exhausting sale need not embody the entire claimed invention where the novelty of the invention resided in the entire combination of elements, rather than in a particular element.
As another example, the courts might treat differently those biotechnology inventions that are self-replicating, where a license to use the invention does not ordinarily confer a right to make as well. Quanta did not raise the unique issues such cases present.

James J. Foster is a veteran patent trial lawyer and senior member of the litigation practice group at Wolf Greenfield, a leading intellectual-property law firm in Boston. He can be reached at [email protected] or 617.646.8225.