Mf Newsletter Jun08

JUNE 2008

Quanta v. LGE, 128 S. Ct. 2109 (2008)

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As reported in our newsletter earlier this year, the

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Supreme Court had granted certiorari in Quanta v. LGE to review California

the Federal Circuit’s holding that “expressly conditional” sales

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negated operation of the patent exhaustion doctrine. The Court

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heard oral argument on January 16, 2008 and issued its long-

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During the 2007 term, it took the Supreme Court an average of 96 days from the hearing date to issue a decision.

awaited decision on June 9, 2008. The facts were straightforward. LGE owned patents relating to microprocessors and licensed Intel to sell these products to its customers. However, the license to Intel purported to expressly disclaim any license to Intel customers who combined the licensed products with non-Intel products, and further required that Intel notify its customers that they were not authorized to make such combinations. Intel’s customers, including Quanta, nonetheless combined the licensed microprocessors with other non-Intel components and in so doing practiced the asserted apparatus and method

Other components may include a memory which is an integral part of a computer system. Quanta combined the Intel components with generic memory chips and buses.

patents. At the Federal Circuit, the defendants argued that the authorized sale by Intel exhausted LGE’s rights in the apparatus and method patents. The Federal Circuit held there was no exhaustion of the apparatus claims because exhaustion does

JUNE 2008

not apply to an expressly conditional sale or license. The Federal Circuit also reiterated its per se rule that method claims could not be exhausted. Per Se is a Latin phrase which literally means “by/in itself,” and used in attorney talk for “simply as such” or “in its own nature without reference to its relation.”

The Supreme Court reversed the Federal Circuit on all counts. Writing for a unanimous Court, Justice Thomas first addressed method claims. LGE argued that because method patents are not linked to tangible articles, they cannot be exhausted by a sale of an article. The Court summarily rejected LGE’s proposition, stating “[i]t 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 saw the purported issue as one of form over substance, observing that “[p]atentees seeking to

A method claim defines an invention in terms of its function (i.e., what it does or how it is done) rather than its structure. A method claim is usually interpreted literally, in light of— b ut not strictly limited to—the specification.

avoid patent exhaustion could simply draft their claims to describe a method rather than an apparatus.” The Court expressed concern for “the danger of allowing such an end run around exhaustion.” The Opinion next considered “the extent to which a product must embody a patent in order to trigger exhaustion.” This consideration was necessary to the Court’s analysis because LGE’s asserted patents covered systems and methods which were not fully practiced by the components sold by Intel. The Court followed the 1942 Univis decision to hold that exhaustion is triggered by the authorized sale of an article containing the “essential, or inventive, feature” of the asserted patent. The Court equated the Intel components to the lens blanks of Univis , observing that the Intel components “constitute a 1

material part of the patented invention and all but completely practice the patent.” The Intel The first electronic computer (a predecessor of the technology at issue in the Quanta case) was developed in the United States in 1942, the same year the Univis case was decided.

component was held to “substantially embod[y] the patent because the only step necessary to practice the patent is the application of common processes or the addition of standard parts.” Critically, the Court stated that “[e]verything inventive about each patent is embodied in the Intel Products.” The Court thus clearly held that the “essential features” of the Univis standard are the “inventive” or “novel” features, i.e., the patentably distinctive features of the method or apparatus claim which is asserted to be exhausted by the sale of a component embodying those features.

JUNE 2008

The Court also made clear that “the exhaustion analysis is not altered by the fact that more than one patent is practiced by the same product.” LGE had asserted that it had other, unasserted, patents which covered the components. The Court was not swayed by this argument, instead holding “[t]he relevant consideration is whether the Intel Products that partially practice a patent—by, for example, embodying its essential features— exhaust that patent.” This conclusion followed necessarily from the Court’s “essential, or inventive, feature” holding. The important point here is that the existence of separate patents covering the component and combination/method will not prevent operation of the exhaustion doctrine unless the component does not embody the inventive feature of the combination/method. The Court next turned to whether there was an authorized sale of the components which embodied the asserted patents. The Court held that the component sales were “not conditioned on the notice or on Quanta’s decision to abide by LGE’s directions in that notice.” Moreover, LGE’s argument that it had disclaimed any license to third parties was Under the doctrine of implied license, a patent holder who sells a product covered by a patent typically grants the purchaser an implied license under the patent, i.e., the right to use and resell the product. The doctrine allows a defendant to avoid liability for patent infringement by a showing that (1) the patented product has no non-infringing uses, and (2) the circumstances of the sale plainly indicate that a license should be inferred.

rejected as being applicable only to the implied license doctrine—but not to patent exhaustion. The Court thus made clear that implied licenses are disclaimable by contract but exhaustion is not. The Court stressed that, notwithstanding LGE’s restrictions, “[n]o conditions limited Intel’s authority to sell products substantially embodying the patents.” Intel was authorized to sell the components to customers who intended to combine them with non-Intel components and thus exhaustion applied to components substantially embodying the patents. The clear directive is that an exclusion of the right to sell components will preclude patent exhaustion with respect to downstream customers. This means that exhaustion will be avoided if a licensee is granted a limited license sufficient to immunize the licensee for its own use, but excludes any right to sell to customers. The licensee will not be precluded from selling to customers, but the customers will have to pay for their own license. Alternatively, with this bright line rule now established, licensees will have to pay much more to include their customers within the scope of a license because licensors

JUNE 2008

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will know that further royalties will not be recoverable from customers of a licensee if the

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license gives the right to sell products substantially embodying the patents.

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The Court noted in a footnote that its decision did not necessarily limit other California 44 Montgomery Street San Francisco, CA 94104 Tel: (415) 318-8800 Washington, DC 1775 I Street NW Washington, DC 20006 Tel: (202) 857-7887

contract rights, such as a claim for breach of contract, which might be applicable even though exhaustion precluded patent damages. However, patent exhaustion typically applies in situations where downstream customers have no contract with the patentee. But in a situation such as presented in this case, where the licensee was required to give notice to the customers, the Court leaves open the possibility of recovering contract damages from the customers. The enforceability of such restrictions against a downstream purchaser who is not a party to the contract is questionable, but system integrators should carefully review any terms of sale or notices they have agreed to or are presented with in the future. For a thorough treatment of the patent exhaustion doctrine, see A Coherent View of

Patent Exhaustion: A Standard Based on Patentable Distinctiveness and Justice Breyer’s Bicycle and the Ignored Elephant of Patent Exhaustion: An Avoidable Collision in Quanta v. at

LGE,

http://www.morganfinnegan.com/news/articles_publications,

which

predicted and provided the basis for the Court’s holding in Quanta v. LGE. Morgan & Finnegan, L.L.P. is a registered limited liability law partnership and maintains offices in New York, the District of Columbia and California for the practice of law. The materials in this newsletter have been prepared by Morgan & Finnegan for informational purposes only and should not be construed as legal advice. Access to the materials or transmission or receipt of the materials is not intended to create and does not create an attorney-client relationship. The newsletter was prepared by Morgan & Finnegan partner John Osborne and associate Sergey Kolmykov.

1

In United States v. Univis Lens Co., 316 U.S. 241 (1942), the Supreme Court held that a patentee’s rights in finished eye-

glass lenses did not survive a licensed manufacturer’s sale of lens blanks to downstream wholesalers and retailers, who then ground the lenses into finished products. The Univis court concluded that the patentee’s rights were exhausted because the partially completed article (lens blank) sufficiently embodied patents directed to a finished lens and related manufacturing methods (via incorporation of the patents’ “essential features”) such that the only use for the lens blank was as a finished product.