Supreme Court Reaffirms Principles of Patent Exhaustion in Quanta Computer v. LG Electronics, No. 06-937

Joshua Sarnoff
June 9, 2008

In a widely anticipated case, the Supreme Court issued a unanimous but narrow decision holding that the sale by an authorized licensee (Intel Corp.) of computer microprocessors and chipsets that “substantially embodied” LGE’s patented methods of retrieving, processing, and transferring stored data “exhausted” LGE’s patent rights, and thus the purchaser of the microprocessors and chipsets (Quanta) was not liable for selling completed computers that integrated the microprocessors and chipsets. Specifically, the Court’s holding was carefully based on the language of the license to Intel, which the Court held did not restrict the sale of microprocessors and chipsets by Intel, so that their sale by Intel terminated any patent rights of LGE in the sold articles (and the computers into which they were subsequently inserted by Quanta). "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.... 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 License Agreement authorized Intel to sell products that practiced the LGE Patents. No conditions limited Intel’s authority to sell products substantially embodying the patents." Slip opinion at 17-18.

Although the holding is significant in two respects, it is also unsatisfying by failing to address the most important issues raised in the case – i.e., what makes a sale authorized and whether explicit contractual restrictions can prevent an authorized sale and thus prevent patent exhaustion. First, the Court overturned a broad holding of the U.S. Court of Appeals for the Federal Circuit that sales of devices cannot exhaust method claims. Second, the Court held that exhaustion is triggered by an unconditional authorized sale when the “only reasonable and intended use” for the sold devices was “to practice the patent” and when the devices “embodie[d] essential features of the patented invention.” Slip opinion at 12. This holding is likely to promote significant litigation regarding alternative uses and essential features of patented inventions. (The Court also expressed a very different view from that expressed by the Federal Circuit of the nature of sales under Intel’s manufacturing license.) But the Court simply failed to address (and thus preserved for now) the more important questions that were raised in the case, choosing to focus on the specific facts of the Intel license. Under current Federal Circuit law, reflected in its decision in Mallinkrodt v. Medipart, 976 F.2d 700 (Fed. Cir. 1992), a patent holder may expressly condition a license to make clear exhaustion will not apply (on the theory that the parties have bargained for less than the full set of patent rights).

The most likely practical effect of the decision will be for patent holders to review and where appropriate renegotiate their licenses to enlist manufacturing licensees in efforts to price discriminate and to impose downstream use restrictions. If the license does not authorize downstream uses, then the manufacturer will also need to consider its potential liability for such uses (and possibly need to negotiate with purchasers over indemnities). The decision is certain to result in more attention to the terms of licensing contracts by patent holders, manufacturers, and purchasers, but it unlikely to have any significant long-term effect on patent law or practices.




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