If you are a patent licensee, are you permitted to sell your
products without the risk of exposing your customers to patent
infringement or royalty claims from the patentee? The recent
ruling from the US Supreme Court in Quanta Computer,
Inc. v. LG Electronics, Inc. clarifies a patent
licensee's position by finding that the patent
exhaustion doctrine applies to method patents. According to
this decision, if a licence agreement authorizes the sale of
components that "substantially embody" a patented
method, then the patent holder will not be entitled to collect
further royalties from downstream purchasers.
LG licensed three computer chip and system patents to Intel
Corporation. Under the terms of the licence agreement, Intel
was authorized to make and sell its own microprocessors and
chipsets that use the LG patents. The agreement also permitted
Intel to "make, use, sell (directly or indirectly), offer
to sell, import or otherwise dispose of" its own products
practising the LG patents. The agreement between LG and Intel
disclaimed any licence to downstream users if they were to
combine the licensed products with non-LG or non-Intel
Intel and LG had entered into a separate agreement that
required Intel to give its customers written notice that the
licence did not extend to a product made by combining an Intel
product with a non-Intel product. A breach of that agreement,
however, did not terminate the licence agreement.
Quanta purchased Intel microprocessors and chipsets, then
manufactured computers using Intel parts, without modification,
in combination with non-Intel components in ways that practise
the LG patents. LG sued Quanta, alleging that the combination
of the Intel products with non-Intel memory and buses
constituted patent infringement.
The Supreme Court found in favour of Quanta, concluding that
LG could no longer assert its patents against Quanta. As part
of its analysis, the Supreme Court considered the
Does the patent exhaustion doctrine apply to method
What triggers patent exhaustion?
Did an authorized sale occur?
Does Patent Exhaustion Apply To Method Claims?
Under the doctrine of patent exhaustion, the "initial
authorized sale of a patented item terminates all patent rights
to that item." LG argued that the doctrine does not apply
to method claims, because method patents are linked to a
process as opposed to a tangible article — and
therefore they could never be exhausted through a sale.
While the Supreme Court accepted that a patented method may
not be sold in the same way as an article or device, methods
could still be "embodied" in a product and the sale
of that product would exhaust patent rights. Otherwise
patentees would be able to circumvent the doctrine simply by
inserting method claims into the patents, and expose downstream
purchasers to liability.
What Triggers Patent Exhaustion?
The court observed that the Intel microprocessors and
chipsets could not function until they were connected to buses
and memory in a computer system. Because the components had no
reasonable non-infringing use and included all the inventive
aspects of the patented methods, the court found that the Intel
components "substantially embodied" the LG patents.
Consequently, it determined that the exhaustion doctrine was
triggered by the sale of the Intel components.
Did An Authorized Sale Occur?
The court then considered whether Intel's sale to
Quanta exhausted LG's patent rights. LG argued that the
sale to Quanta was not authorized by the licence agreement.
However, the court found that the agreement did not restrict
Intel's right to sell its microprocessors and chipsets
to purchasers who intended to combine them with non-Intel
LG tried to rely on the clause in the licence agreement that
disclaimed any downstream licence in the circumstances, but the
court held that Quanta's right to practise the patents
was based on exhaustion and not on implied licence. Since it
found that the agreement authorized Intel to sell products that
practised the LG patents, the court determined that the patent
exhaustion doctrine prevented LG from further asserting its
patent rights against Quanta and other downstream purchasers of
the Intel products.
McCarthy Tétrault Notes:
In light of this decision, current licence agreements should
be reviewed carefully with the extended notion of exhaustion in
mind. If a licence agreement excludes the right to sell, or
provides for limited rights to sell, the licensor may be
entitled to royalties or damages from unauthorized purchasers
since the exhaustion doctrine only applies to authorized sales.
If the agreement provides for broad rights to sell, the
licensor may consider increasing the royalties payable by the
licensee to take into account any unrecoverable royalties from
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