United States: Contractual Restriction In License Agreement Prevents Patent Exhaustion By Restricting Scope Of Licensed Sales Rather Than Use Of Products After Authorized Sale By Licensee

Abstract

The doctrine of patent exhaustion provides that the initial authorized sale of a patented item, directly or through a licensee, terminates all patent rights to that item. And a contractual restriction in a license agreement on the use of an otherwise-licensed product does not prevent patent rights from being exhausted.  In a recent case, a Texas court found that a contractual restriction in a license agreement did not result in patent exhaustion because the restriction limited the scope of sales that were licensed rather than limiting the use of products after an authorized sale by the licensee. Therefore, the licensee's sale outside the scope of the license agreement did not exhaust the patent owner's patent rights.

An authorized sale of a patented product exhausts all patent rights to that product. Patent exhaustion is "uniform and automatic." It applies to sales made by the patent owner and sales the patent owner authorizes a licensee to make. If a patent owner imposes contractual restrictions on how the patented product may be used after an authorized sale, such restrictions may be enforceable against the licensee under contract law, but are not enforceable through patent law against the licensee's customers. 

In Chrimar Systems, Inc. et al. v. Alcatel-Lucent Enterprise USA, the court found that a contractual restriction in a license agreement prevented patent exhaustion because the restriction limited the scope of sales that were licensed under the agreement rather than the use of products after an authorized sale by the licensee. In other words, because the license limited the scope of customers that the licensee could sell to, sales outside that scope were unauthorized and did not trigger patent exhaustion. As a result, the patent owner could sue and recover damages from its licensee's customer for such unauthorized sales under patent law. 

Background

Patent owner Chrimar prevailed in an infringement action against Alcatel-Lucent and received past damages and on-going royalties for Alcatel-Lucent's sale of infringing products. In a separate lawsuit, Chrimar accused one of Alcatel-Lucent's suppliers, Accton, of infringement for selling and importing of some of the same products involved in the lawsuit against Alcatel-Lucent. Chrimar and Accton finalized a settlement agreement after the jury reached a verdict against Alcatel-Lucent, but before a final judgment was entered. Under the settlement agreement, infringing products sold by Accton to "a company currently in litigation with Chrimar" were considered "Unlicensed Products." 

Following the Supreme Court's decision in Impression Products, Alcatel-Lucent moved under Fed. R. Civ. P. 60(b) to modify the final judgment to exclude damages and ongoing royalties based the sale of products Accton supplied to Alcatel-Lucent. In seeking relief, Alcatel-Lucent asserted that Chrimar exhausted certain rights when it licensed the patents to Accton. 

The Chrimar Decision

The court denied Chrimar's motion, concluding that Accton's sales of infringing products to a customer in active litigation with Chrimar were unauthorized under the terms of the settlement agreement. As such, those sales did not exhaust the Chrimar's right to recover damages from Alcatel-Lucent. 

Distinguishing Impression Products, the court found that the provision of the settlement agreement defining Accton's products sold to "a customer in active litigation with Chrimar" as "Unlicensed Products" was not an improper post-sale restriction. Instead, that provision defined sales that exceeded the scope of the license, and were therefore not authorized by the patent owner. Based on the standing principle that if a patent owner has not given authority for a licensee to make a sale, that sale cannot exhaust the patent owner's rights, the court found Accton's sales to Alcatel-Lucent could not exhaust Chrirmar's rights. 

The court explained that this principle made sense because the parties agreed to a specific payment knowing that the agreement did not include infringing products sold to customers involved in active litigation with Chrimar. Given the settlement agreement, Chrimar would have to seek recovery for sale of the unlicensed products directly from the customers in active litigation selling or importing products covered by the patents.

Strategy and Conclusion

Only an authorized sale, direct or through a licensee, triggers patent exhaustion. Whether or not a sale by a licensee is authorized depends on the scope of the license. Patent owners negotiating settlement or license agreements with suppliers of infringing products may inadvertently exhaust their right to recover damages from customers of the suppliers that may also be liable for infringement if the scope of the license agreement is broader than intended. Patent owners may enforce provisions in the license agreement that restrict the use and sale of the patented product after an authorized sale against a licensee under contract law, but cannot enforce those provisions under patent law against the licensee's customers. 

The Chrimar opinion can be found  here.

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