United States: Patent Exhaustion Principles Apply To All Authorized Transfers Of Title In Property Regardless Of Whether The Transfer Constitutes A Gift Or Sale

In LifeScan Scotland, Ltd. v. Shasta Technologies, LLC, No. 13-1271 (Fed. Cir. Nov. 4, 2013), the Federal Circuit reversed an order granting a preliminary injunction blocking sales of blood glucose test strips for use in LifeScan Scotland, Ltd. and LifeScan, Inc.'s (collectively "LifeScan") blood glucose meters because Shasta Technologies, LLC; Conductive Technologies, Inc.; Instacare Corp.; and Pharmatech Solutions, Inc. (collectively "Shasta") established the defense of patent exhaustion.

U.S. Patent No. 7,250,105 ("the '105 patent"), owned by LifeScan, describes and claims an improved method of comparing the measurements taken by two separate electrodes embodied in LifeScan's meters. LifeScan distributed 60 percent of its meters through healthcare providers who gave it to patients for free, and LifeScan sold the remaining 40 percent below cost. LifeScan admitted to using this form of distribution with the expectation that it would derive a profit from customers purchasing its test strips for use in its meters. Shasta only competes with LifeScan in the test strip market, and Shasta's test strips are designed for use in LifeScan's meters.

LifeScan filed suit against Shasta alleging indirect infringement of the '105 patent and also sought a preliminary injunction barring Shasta from selling or offering to sell its competing test strip. As a defense, Shasta argued that the preliminary injunction should not issue because the sale and distribution of LifeScan's meters exhausted LifeScan's patent rights because the meters substantially embodied the '105 patent. The district court found that the preliminary injunction factors favored LifeScan because the transfer of meters either by sale or gift did not exhaust LifeScan's rights since the meters did not embody the claims of the '105 patent. Accordingly, the district court issued the preliminary injunction, and Shasta appealed.

On appeal, LifeScan argued that distribution of its meters, whether by sale or gift, did not trigger exhaustion because its meters did not substantially embody the claims of the '105 patent. At the outset, the Federal Circuit noted that because the asserted '105 patent claims were method claims, the issue is governed by the Supreme Court's decision in Quanta Computer, Inc. v. LG Electronics, Inc., 553 U.S. 617 (2008). In Quanta, the Supreme Court "stated that it had 'repeatedly held that method patents were exhausted by the sale of an item that embodied the method.'" Slip op. at 11 (quoting Quanta, 553 U.S. at 629). LifeScan raised a number of arguments why patent exhaustion did not apply. The Court addressed and rejected each argument in turn.

"[A] patentee has a choice as to how to secure its reward. . . . But a patentee cannot evade patent exhaustion principles by choosing to give the article away rather than charging a particular price for it. Where a patentee unconditionally parts with ownership of an article, it cannot later complain that the approach that it chose results in an inadequate reward and that therefore ordinary principles of patent exhaustion should not apply." Slip op. at 25.

Addressing LifeScan's argument that Quanta did not apply to the present case because there were reasonable noninfringing uses for its meters, the Federal Circuit indicated that it had recently rejected that contention "where the use in question is the very use contemplated by the patented invention itself." Id. at 12-13 (citing Keurig, Inc. v. Sturm Foods, Inc., No. 13-1072, slip op. at 7 (Fed. Cir. Oct. 17, 2013)). The Court also explained that even if a reasonable noninfringing use were sufficient to avoid exhaustion, there is no suggestion here that the users could put LifeScan's meters to noninfringing uses. Further, the Federal Circuit found that LifeScan admitted it distributed the meters with the expectation and intent that they be used with its test strips. Based upon this finding, where alternative uses that might not infringe were not intended, the Court found alternative uses are irrelevant to the issue of patent exhaustion.

Turning to LifeScan's next argument that exhaustion did not apply because the meters did not embody the essential features of the '105 patent, the Federal Circuit indicated that the question here is whether the meters "control" and "carry out" the inventive functions described in the method claims of the '105 patent. In determining what is an "essential" feature of the '105 patent, the Court queried what was "inventive," which in the exhaustion context turns on what distinguishes the patent claims from the prior art. Id. at 13-14. Taking into consideration the prosecution history, the Court found the "'measuring,' 'comparing,' and 'giving an indication of an error' steps distinguished the method claims from the prior art, not the arrangement of the electrodes," and held the meters embodied the essential features of the '105 patent because the meters "control" and "carry out" the inventive functions of the method claims. Id. at 16-17. The Court maintained that "[h]aving secured a patent premised on the inventive quality of the comparing function, rather than the particular strip configuration, LifeScan cannot now argue the contrary for purposes of exhaustion." Id.

The Federal Circuit noted that LifeScan also appeared to argue that the test strips themselves were separately patentable. The question, however, was found not to be whether the strips would have been separately patentable, but rather "whether the strips embodied the inventive features of the claims that were actually allowed by the examiner." Id. at 17. In this case, the Court found that the examiner did not find the test strips embodied inventive features because claims directed to the test strips themselves were not allowed, and the inventive features identified during examination were performed by the meter. While acknowledging that the analysis would be different if a patent had actually issued on the test strips, the Court rejected LifeScan's argument that exhaustion did "not apply because the strips . . . [were] not 'standard' parts." Id. at 20.

Discussing the policy implications of rejecting the claim of exhaustion in this case, the Federal Circuit indicated that doing so would be "particularly problematic because LifeScan would be permitted to eliminate competition in the sale of the strips even though the strips do not embody the claimed invention and are themselves not patentable." Id. at 21. The Court concluded that the sale of the meter exhausted LifeScan's patent rights because to bar the use of the meter with the test strips manufactured by Shasta "would bar the use of the meters for their contemplated function and extend the patent monopoly improperly." Id. at 22 (citing Keurig, No. 13-1072, slip op. at 7).

Turning to LifeScan's final argument, the Federal Circuit—recognizing the issue as a matter of first impression—was asked to decide whether patent exhaustion applies to a product distributed for free. The Court concluded that, "in the case of an authorized and unconditional transfer of title, the absence of consideration is no barrier to the application of patent exhaustion principles." Id. at 23. Although the Supreme Court has discussed exhaustion in terms of "sales" and "purchasers," the Federal Circuit explained that "the Court has more fundamentally described exhaustion as occurring when the patented product 'passes to the hands' of a transferee and when he 'legally acquires a title' to it." Id. at 24 (citations omitted). The Court found LifeScan's position "inconsistent with the doctrine's underlying rationale—to permit the owner of an item who received it in an authorized transfer to use it." Id. Where LifeScan chose to give meters away for free in order to increase sales of its test strips, it should not be allowed to evade patent exhaustion.

The Federal Circuit found that the principles of patent exhaustion apply even where there is an apparent lack of consideration. Finding additional support for its finding of exhaustion in precedent premised on copyright law's first sale doctrine, the Court stated that, "[a]bsent a valid contractual restriction, restraints upon the downstream use or sale of a patented product 'offend against the ordinary and usual freedom of traffic in chattels,' and that is so regardless of the amount of consideration demanded by the patentee when it originally parted with the product." Id. at 28 (quoting John D. Park & Sons Co. v. Hartman, 153 F. 24, 39 (6th Cir. 1907)). Accordingly, the Court concluded that patentees cannot circumvent the application of patent exhaustion principles by the free distribution of a product embodying a patent, and reversed and remanded for further proceedings.

Judge Reyna, dissenting, disagreed "with the patentability gloss that the majority casts on the otherwise straightforward exhaustion standard expressed in Quanta." Reyna Dissent at 2. Judge Reyna found that the pivotal issue was whether the meters or the test strips embodied the essential features of the '105 patent. Judge Reyna concluded that the test strips, and not the meters, embodied those essential features. Indeed, Judge Reyna opined that "[t]he majority's apparent misunderstanding of the [Supreme] Court's guidance in Quanta causes it to err in two separate respects." Id. at 4. First, Judge Reyna took issue with the majority's finding that the meter alone embodied the essential features of the '105 patent because "[t]he steps performed by the meter, 'measuring,' 'comparing,' and 'giving an indication of an error,' are only made possible by the unique configuration of the three electrode test strip." Id. at 5-6. Second, Judge Reyna found the requirement that the test strips be separately patentable was improper and inconsistent with Supreme Court precedent. Accordingly, Judge Reyna concluded that, "[b]ecause LifeScan's test strips embody the essential features of its patented method, the majority erred by finding exhaustion applied once the meter is sold (or given away)." Id. at 12-13.

Judges: Dyk (author), Prost, Reyna (dissenting)

[Appealed from N.D. Cal., Judge Davila]

This article previously appeared in Last Month at the Federal Circuit, December 2013.

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