RECONCILING THE PATENT EXHAUSTION AND CONDITIONAL SALE DOCTRINES IN LIGHT OF QUANTA COMPUTER V. LG ELECTRONICS

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1 RECONCILING THE PATENT EXHAUSTION AND CONDITIONAL SALE DOCTRINES IN LIGHT OF QUANTA COMPUTER V. LG ELECTRONICS Erin Julia Daida Austin * INTRODUCTION Imagine that Seller owns a valid patent for technology incorporated into a machine that produces widgets. Buyer purchases the widget machine from Seller. As a condition of the purchase, Buyer promises to restrict his use of the machine in some respect. For example, Buyer may promise eventually to return the used machine only to Seller and not to any third-party refurbisher or reseller. 1 Or Buyer may promise to use the machine to produce no more than one thousand widgets, after which point Buyer promises to dispose of the machine. 2 Perhaps Buyer promises to use the machine only to produce widgets for personal use and not for commercial use. 3 If Buyer violates such a promise, should Seller have a cause of action against Buyer for breach of contract, for patent infringement, or for both? Significant debate exists about whether or to what degree patentees 4 should be able to enforce post-sale restrictions 5 against * J.D. Candidate (June 2010). I would like to thank my husband and daughter, Joel and Sophie, for their encouragement and support. Thank you also to Professor Alan Wolf, Victoria Elman, and Etan Chatlynne for their advice and comments on this Note. 1 This restriction is inspired by Ariz. Cartridge Remfrs. Ass n v. Lexmark Int l Inc., 421 F.3d 981 (9th Cir. 2005). 2 The restriction on the number of widgets produced is inspired by Mallinckrodt v. Medipart, 976 F.2d 700 (Fed. Cir. 1992). 3 The restriction on the type of use is inspired by Gen. Talking Pictures Corp. v. W. Elec. Co., 304 U.S. 175 (1938). 4 A patentee is the owner of the monopoly rights under an issued patent. See infra note 10. An assignee of rights under the patent stands in the same shoes. E.g., DONALD S. CHISUM, CHISUM ON PATENTS ( Patents are subject to general legal rules on the ownership and transfer of property. The patent statutes provide that a patent shall have the attributes of personal property. They also provide that both patents and patent applications shall be assignable in law by an instrument in writing. (citing 35 U.S.C. 261)). 5 A patentee might desire to restrict the purchaser s right to remake or repair, use, or resell the patented article. Principally at issue in this Note are limitations on the purchaser s right to use the patented article. 2947

2 2948 CARDOZO LAW REVIEW [Vol. 30:6 purchasers, 6 as in the Seller-Buyer example presented, through a suit for patent infringement. 7 Specifically, some see a conflict between the patent exhaustion doctrine, long established by the Supreme Court, 8 and the conditional sale doctrine as recently implemented by the Federal Circuit. 9 While a patent gives the owner the right to exclude others from making, using, or selling the patented invention within the United States, 10 this right is limited by the exhaustion doctrine (also called the first sale doctrine), which holds that the first authorized sale 11 of a patented article removes that article from the patent monopoly such that any subsequent use is not infringement. 12 If patent rights have been exhausted by an authorized sale, post-sale restrictions can only be enforced, if at all, under a contract theory. 13 But the Federal Circuit has held that a conditional sale, in which the patentee restricts the right of 6 A purchaser may buy a patented article directly from the patentee or assignee, or from an intermediate manufacturer licensed to make and sell the patented article. Additionally, the purchaser may be the end user of the patented good, or the purchaser may incorporate the patented article into another article that he then sells. If it should have legal significance whether the purchaser, e.g., buys directly from the patentee versus from an intermediate licensee, this Note so indicates. 7 See, e.g., Mark R. Patterson, Contractual Expansion of the Scope of Patent Infringement Through Field-of-Use Licensing, 49 WM. & MARY L. REV. 157 (2007); William P. Skladony, Quanta Computer v. LG Electronics: The US Supreme Court May Consider the Doctrine of Patent Exhaustion, 19 NO. 7 INTELL. PROP. & TECH. L.J. 1 (2007); Richard H Stern, The Unobserved Demise of the Exhaustion Doctrine in US Patent Law: Mallinckrodt v. Medipart, 15 EUR. INTELL. PROP. REV. 460 (1993). 8 See JAY DRATLER, JR., LICENSING OF INTELLECTUAL PROPERTY 7.05 (noting that the patent exhaustion doctrine is judicially created while the copyright exhaustion doctrine is statutory). 9 See, e.g., Skladony, supra note 7, at 1 ( A tension has developed between these lines of cases, and it is focused for Supreme Court consideration. ); Stern, supra note 7, at 461 (stating that the Mallinckrodt decision recognizing a conditional sale swept away a century or more of exhaustion doctrine ) U.S.C. 281 (2006) (giving a patentee remedy by civil action for infringement of his patent ); 35 U.S.C. 271(a) (2006) ( [W]hoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention during the term of the patent therefore, infringes the patent. ). 11 A sale is the transfer of a piece of property or the title for a price. BLACK S LAW DICTIONARY 631 (3d Pocket ed. 2006). Contrastingly, a license is the transfer of rights in property without transferring the ownership of the property. Dratler, Jr., supra note 8, at E.g., Quanta Computer, Inc. v. LG Elecs., Inc., 128 S. Ct. 2109, 2115 (2008) ( [T]he initial authorized sale of a patented item terminates all patent rights to that item. ); U.S. v. Univis Lens Co., 316 U.S. 241, 250 (1942); Adams v. Burke, 84 U.S. (17 Wall.) 453, (1873); Bloomer v. McQuewan, 55 U.S. 539, (1852). In the Seller-Buyer widget machine example, finding that Seller s patent rights were exhausted would mean that Seller could not sue Buyer for patent infringement based on the manner in which Buyer used the machine U.S. at ( [H]e must seek redress in the courts of the State, according to the laws of the State and not in the courts of the United States, nor under the law of Congress granting the patent ); O.W. HOLMES, JR., THE COMMON LAW 301 (1881) ( The only universal consequence of a legally binding promise is, that the law makes the promisor pay damages if the promised event does not come to pass. ). In the Seller-Buyer widget machine example, Seller could sue Buyer for breach of contract, but not for patent infringement, based on Buyer s use of the machine in violation of his promise.

3 2009] EXHAUSTION AND CONDITIONAL SALE 2949 the purchaser to use the patented article through an enforceable contract, can prevent exhaustion and preserve the patentee s right to sue for infringement if the condition is not met or the restriction is violated. 14 Thus, in the example above, the exhaustion doctrine would limit Seller to a suit for breach of contract while the conditional sale doctrine would allow Seller to sue Buyer for patent infringement and breach of contract. Whether patent rights may be preserved by a conditional sale is important because of several significant differences between a cause of action for patent infringement and a cause of action for breach of contract. First, activity that is found to be within the scope of a valid patent grant is subject to lower antitrust scrutiny than activity that is not conducted under the auspice of a patent. 15 Second, whereas damages for breach of contract are generally compensatory, 16 patentees may 14 E.g., B. Braun Med., Inc. v. Abbott Labs., 124 F.3d 1419, 1426 (Fed. Cir. 1997); Mallinckrodt v. Medipart, 976 F.2d 700, 709 (Fed. Cir. 1992); PATENTS AND THE FEDERAL CIRCUIT 14.3 (8th ed., BNA, 2007) ( [The] exhaustion doctrine, however, does not apply to an expressly conditional sale or license. ). For example, in the Seller-Buyer widget machine hypothetical, finding that the sale of the machine was conditioned on Buyer s use of the machine and that Buyer s use violated the condition would mean that Seller could sue Buyer for patent infringement. 15 Patterson, supra note 7, at 165 (noting that contractual restrictions do not receive any of the protection from antitrust scrutiny that might be accorded a restriction under patent law ); DONALD S. CHISUM, CHISUM ON PATENTS: A TREATISE ON THE LAW OF PATENTABILITY, VALIDITY, AND INFRINGEMENT 19.04(2) (2008) ( Both the misuse doctrine and the antitrust laws as applied to patent practices involve a common inquiry: Should the practice in question be treated as an appropriate exercise of the patentee s statutory patent rights? If the answer to the inquiry is affirmative, then the practice is not an improper extension within the meaning of the patent misuse doctrine and should enjoy an immunity from antitrust liability even though but for the patent the practice would violate the antitrust laws. ). But see Atari Games Corp. v. Nintendo of Am., Inc., 897 F.2d 1572, (Fed. Cir. 1990) ( The fact that a patent is obtained does not wholly insulate the patent owner from the antitrust laws. When a patent owner uses his patent rights not only as a shield to protect his invention, but as a sword to eviscerate competition unfairly, that owner may be found to have abused the grant and may become liable for antitrust violations when sufficient power in the relevant market is present. (internal citations omitted)). 16 UCC ( The remedies provided by this Act shall be liberally administered to the end that the aggrieved party may be put in as good a position as if the other party had fully performed but neither consequential or special nor penal damages may be had.... ) (2007); ARTHUR LINTON CORBIN, CORBIN ON CONTRACTS 55.3 (2008) ( In determining the amount of this compensation as the damages to be awarded, the aim in view is to put the injured party in as good a position as that party would have been in if performance had been rendered as promised.... As a corollary to this proposition it is a basic tenet of contract law that the aggrieved party will not be placed in a better position than it would have occupied had the contract been fully performed. ); Id. at 59.2 ( Although such awards are increasingly important in tort litigation, punitive damages are usually not awarded in contract actions, no matter how egregious the breach. It is often said that the rules as to damages for breach of contract are applied for the purpose of giving compensation for injury done, and not for punishment of a wrongdoer. ); E. ALLEN FARNSWORTH, FARNSWORTH ON CONTRACTS 12.8, at (1990) ( Furthermore, no matter how reprehensible the breach, damages that are punitive, in the sense of being in excess of those required to compensate the injured party for the lost expectation, are not ordinarily awarded for breach of contract. ). But see id. at (detailing the increasing frequency with which courts grant punitive damages in breach of contract cases).

4 2950 CARDOZO LAW REVIEW [Vol. 30:6 recover treble damages 17 and attorney s fees 18 for successful claims of willful patent infringement. 19 Third, patentees may obtain injunctions to enjoin infringing activity for the remainder of the patent term, 20 while U.S.C. 284 (2006) ( [T]he court may increase the damages up to three times the amount found or assessed. ). A finding of willful infringement is a sufficient basis for increased damages. See, e.g., Johns Hopkins Univ. v. CellPro, Inc., 152 F.3d 1342, 1364 (Fed. Cir. 1998) ( [I]t is well established that enhancement of damages may be premised upon a finding of willful infringement. ); Beatrice Foods Co. v. New England Printing and Lithographing Co., 923 F.2d 1576, 1578 (Fed. Cir. 1991) ( [I]t is well-settled that enhancement of damages must be premised on willful infringement or bad faith. (quoting Yarway Corp. v. Eur-Control USA, Inc., 775 F.2d 268, 277 (Fed. Cir. 1985))). However, a finding of willful infringement does not require an award of treble damages. Modine Mfg. Co. v. Allen Group, Inc., 917 F.2d 538, 543 (Fed. Cir. 1990) ( [A] finding of willful infringement merely authorizes, but does not mandate, an award of increased damages. ) (emphasis in original); Robert W. Morris, Note, Another Pound of Flesh : Is There a Conflict Between the Patent Exhaustion Doctrine and Licensing Agreements?, 47 RUTGERS L. REV. 1557, 1571 (2007) ( The goal of monetary relief is to restore the patent owner to the financial position he would have enjoyed had the infringement not occurred. ) U.S.C. 285 (2006) allows the court to award the prevailing party attorney s fees in an exceptional case. Modine, 917 F.2d at 543 ( An express finding of willful infringement is a sufficient basis for classifying a case as exceptional, and indeed, when a trial court denies attorney fees in spite of a finding of willful infringement, the court must explain why the case is not exceptional within the meaning of the statute. ). 19 See Kimberly A. Moore, Empirical Statistics on Willful Patent Infringement, 14 FED. CIR. B.J. 227 (2004). Moore analyzed 1721 patent infringement cases for which litigation terminated from and found that willful infringement was alleged in 92.3% of complaints. Id. at 232. Of 143 studied cases that went to trial, willfulness was found 55.7% of the time, and enhanced damages were awarded in 55.7% of cases where willfulness was found. Id. at 237. In other words, enhanced damages were awarded in 31.0% of the 143 tried cases U.S.C. 283 (2006) ( The several courts having jurisdiction of cases under this title may grant injunctions in accordance with the principles of equity to prevent the violation of any right secured by patent, on such terms as the court deems reasonable. ). A recent Supreme Court opinion rejected a general rule that injunctions should be the remedy for patent infringement. ebay, Inc. v. MercExhange, L.L.C., 547 U.S. 388 (2006). Granting a permanent injunction for the patentee, the Federal Circuit stated that courts will issue permanent injunctions against patent infringement absent exceptional circumstances. MercExchange, LLC v. ebay, Inc., 401 F.3d 1323, 1339 (Fed. Cir. 2005), rev d 547 U.S The Supreme Court reversed, holding that injunctions should issue under the Patent Act according to the traditional four-factor test employed by courts of equity requiring the plaintiff to demonstrate: (1) that it has suffered an irreparable injury; (2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury; (3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and (4) that the public interest would not be disserved by a permanent injunction. 547 U.S. at Nonetheless, injunctions are still often found to be an appropriate remedy in infringement suits: From at least the early 19th century, courts have granted injunctive relief upon a finding of infringement in the vast majority of patent cases. This long tradition of equity practice is not surprising, given the difficulty of protecting a right to exclude through monetary remedies that allow an infringer to use an invention against the patentee s wishes-a difficulty that often implicates the first two factors of the traditional four-factor test. This historical practice, as the Court holds, does not entitle a patentee to a permanent injunction or justify a general rule that such injunctions should issue.... At the same time, there is a difference between exercising equitable discretion pursuant to the established four-factor test and writing on an entirely clean slate..... in this area as others, a page of history is worth a volume of logic.

5 2009] EXHAUSTION AND CONDITIONAL SALE 2951 injunctions are less frequently granted in contract cases. 21 Fourth, while a claim for breach of contract can only be brought against one with whom the complainant has privity of contract 22 or a third-party beneficiary relationship, 23 a patent infringement suit requires no special relationship between the patentee and the alleged infringer. 24 A fifth consideration is that the Federal Circuit has exclusive 25 jurisdiction over appeals related to patent cases, 26 whereas breach of contract is generally a state law issue. 27 Patentees may prefer the Federal Circuit since it is 547 U.S. at 395 (Roberts, C.J., concurring) (internal citations omitted, emphasis in original); Benjamin Petersen, Note, Injunctive Relief in the Post-eBay World, 23 BERKELEY TECH. L.J. 193, 217 (2008) ( Although injunctive relief is no longer nearly automatic, post-ebay district court decisions do not suggest that injunctions are now rare. Indeed, the effect of ebay seems limited almost exclusively to non-practicing patent holders who are not in direct competition with the infringer. ). 21 HOLMES, supra note 13; 25 WILLISTON ON CONTRACTS 67:8 (4th ed.) ( [A]s a general rule, before specific performance may be decreed for breach of a contract... the remedy at law, that is, damages, must first have been determined to be incomplete and inadequate to accomplish substantial justice. ). 22 For an example of the formalistic view requiring privity, see Lawrence v. Fox, 20 N.Y. 268, 275 (1859) (Comstock, J. dissenting) ( In general, there must be privity of contract. The party who sues upon a promise must be the promisee, or he must have some legal interest in the undertaking. ). See also Brief of American Intellectual Property Law Association as Amicus Curiae in Support of Respondent at 32, Quanta Computer, Inc. v. LG Elec.s, Inc., 128 S. Ct (2008) (No ) [hereinafter Brief of AIPLA] ( [C]ontract remedies are not helpful since they are often inadequate to accomplish the objectives because they require privity.... ); Kieff, infra note 168, at 326 ( Even an innocent infringer, without knowledge of a patent, who makes something covered by a valid patent claim with her own hands from materials gathered from land she and her ancestors have owned free and clear since time immemorial, is nonetheless liable for patent infringement. ). 23 Lawrence, 20 N.Y. at 271 ( [W]here one person makes a promise to another for the benefit of a third person, that third person may maintain an action upon it. ). 24 Cf. ProCD, Inc. v. Zeidenberg, 86 F.3d 1447, 1454 (1996) ( A copyright is a right against the world. Contracts, by contrast, generally affect only their parties; strangers may do as they please, so contracts do not create exclusive rights. ). To illustrate, a patentee and alleged infringer need not have bargained for a promise by the alleged infringer that he would not infringe; rather, the patentee has a right to proceed against anyone who makes, uses, or sells her patented article in the United States without her authorization. Many of the cases discussed in this Note involve contracts between the relevant parties, or arrangements that might be classified as third-party beneficiary relationships. However, this Note suggests that whether a patentee can enforce her property rights under the patent law should not turn on whether she has privity with the infringer. 25 To be precise, the Federal Circuit has nearly exclusive jurisdiction over appeals in patent cases. The Federal Circuit does not have exclusive appellate jurisdiction where patent claims arise only in counterclaims and not in the complaint. Holmes Group, Inc. v. Vornado Air Circulation Sys., Inc., 535 U.S. 826 (2002) U.S.C. 1295(a)(1) (2006); Atari, Inc. v. J.S. & A Group, Inc., 747 F.2d 1422 (Fed. Cir. 1984), overruled on other grounds by Nobelpharma Ab. v. Implant Innovations, 141 F.3d 1059 (Fed. Cir. 1998) ( [T]his court s jurisdiction to hear appeals from district court judgments is unique and depends, by statutory direction, on whether the district court s jurisdiction was based, in whole or in part, on [a patent claim under] Section ). 27 Power Lift, Inc. v. Weatherford Nipple-Up Systems, Inc., 871 F.2d 1082, 1085 (Fed. Cir. 1989) ( A [patent] license agreement is a contract governed by ordinary principles of state contract law. ); Aronson v. Quick Point Pencil Co., 440 U.S. 257, 262 (1979) ( Commercial agreements traditionally are the domain of state law. State law is not displaced merely because

6 2952 CARDOZO LAW REVIEW [Vol. 30:6 perceived as being pro-patentee. 28 Because of these differences, patentees may desire to retain patent rights, as opposed to mere contractual rights, by including restrictions in sales or licensing agreements. 29 In Quanta Computer, Inc. v. LG Electronics, Inc., 30 the Supreme Court addressed the rights of patentee LG Electronics ( LGE ) with respect to a purchaser from LGE s licensed manufacturer. LGE licensed intermediate manufacturer Intel to make, use, and sell computer components that practiced LGE s patents. 31 The language of the LGE-Intel licensing agreement purportedly reserved LGE s patent rights against Intel s purchasers. 32 Purchaser Quanta bought components from licensee Intel and assembled them into computers that practiced LGE s patents. 33 When Quanta and Intel s other purchasers refused to pay LGE licensing fees, LGE sued the purchasers for patent infringement. 34 the contract relates to intellectual property.... ). 28 For a list of several articles asserting this view, see Kimberly A. Moore, Markman Eight Years Later: Is Claim Construction More Predictable?, 9 LEWIS & CLARK L. REV. 231, 240 n.32 (2005). But see id. at 241 (noting that, at least with regard to claim construction, the Federal Circuit finds in favor of accused infringers more often than not, belying the claim the that court is pro-patentee). 29 Norman E. Rosen, Intellectual Property and the Antitrust Pendulum: Recent Developments at the Interface Between the Antitrust and Intellectual Property Laws, 62 ANTITRUST L.J. 669, 687 (1994) (stating that damages for patent infringement would generally exceed breach of contract damages ); Elizabeth I. Winston, Why Sell What You Can License? Contracting Around Statutory Protection of Intellectual Property, 14 GEO. MASON L. REV. 93, 108 (2006) ( [P]atent infringement... is likely to be a more lucrative action than breach of contract for violating a license restriction. ). Of course, the two branches of law are not mutually exclusive. It is probably most desirable to have protection under both the patent law and private contract provisions S. Ct (2008). 31 To practice a patent means to make and use the patented invention. For example, this could mean constructing and operating a patented machine or carrying out a patented process S. Ct. at Thus, LGE could sue Intel s purchasers for patent infringement, but Intel would not be contributorily liable even though it had sold components designed to practice LGE s patents. Opinions differ as to whether this aspect of the LGE-Intel agreement was poor drafting, an attempt to trap Intel s purchasers, or savvy strategy based on the state of the law at the time. Compare F. Scott Kieff, Quanta v. LG Electronics: Frustrating Patent Deals by Taking Contracting Options off the Table?, 2008 CATO SUP. CT. REV. 315, (stating that one interpretation of the Quanta opinion is that the LGE-Intel contract was poorly written, but suggesting the real reason the Supreme Court heard the case was to comment on the types of patent licensing agreements that it approves) with Harold C. Wegner, Post-Quanta, Post-Sale Patentee Controls, 7 J. MARSHALL REV. INTELL. PROP. L. 682, 683 (calling LGE s licensing strategy ingenious ) and id. at 690 (describing LGE s licensing strategy as taking full advantage of the Federal Circuit case law ). Without speculating on LGE s intent, the author of this Note acknowledges that the particular language of these agreements creates some uncertainty as to how to interpret the reach of the Quanta opinion S. Ct. at 2113 ( In this case, we decide whether patent exhaustion applies to the sale of components of a patented system that must be combined with additional components in order to practice the patented methods. ). 34 Complaint for Patent Infringement, LG Elecs. Inc. v. Q-Lity Computer Inc., No. C , 2001 WL (N.D. Cal. Apr. 16, 2001).

7 2009] EXHAUSTION AND CONDITIONAL SALE 2953 The Court held that, under the exhaustion doctrine, Intel s authorized sale of components that sufficiently embodie[d] LGE s patents terminated LGE s patent rights. 35 The Court found that the LGE-Intel licensing agreement triggered exhaustion because it gave Intel unconditional authority to sell components that had no reasonable use other than practicing the LGE patents. 36 The Quanta opinion did not explicitly address the broader question of whether patent owners can ever avoid exhaustion through a conditional sale. It is debatable whether the Court s finding regarding the lack of conditionality in the LGE-Intel licensing agreement was based on the specific language of the documents at issue, or whether it was a more general pronouncement against attempts by patentees to reserve rights against purchasers. 37 In the wake of the Quanta decision, some commentators doubt the viability of the conditional sale doctrine as articulated by the Federal Circuit over the past two decades. 38 They have suggested that the Court s conclusion regarding the LGE-Intel agreement implies that a S. Ct. at 2122 ( Because Intel was authorized to sell its products to Quanta, the doctrine of patent exhaustion prevents LGE from further asserting its patent rights with respect to the patents substantially embodied by those products. ). The Court s opinion drew heavily from United States v. Univis Lens Co., 316 U.S. 241 (1942), in which the sufficient embodiment test for exhaustion was first developed. See infra Part I.A. See also infra note 126 for a discussion of when an article sufficiently embodies a patent. 36 Id. at 2122 ( No conditions limited Intel s authority to sell products substantially embodying the patents. ). This is the second prong of the exhaustion test set forth in Univis. See infra Part I.A. 37 See supra note 32 and accompanying text. 38 For commentary arguing that Quanta overrules the conditional sale doctrine articulated in Mallinckrodt, see, e.g., Chris Holman, Quanta and Its Impact on Biotechnology, Holman s Biotech IP Blog (June 11, 2008), (opining that Quanta implicitly overrules Mallinckrodt); Wegner, supra note 32, at 682, 691 (stating that Quanta sub silentio overrules Federal Circuit precedent holding that exhaustion does not apply to expressly conditional sales or licenses). For commentary asserting that Quanta leaves the conditional sale doctrine intact, see, e.g., Dratler, Jr., supra note 12, at 7.05 (stating that the Quanta opinion leaves open the question of the extent to which parties may limit the effect of the exhaustion doctrine through the language of their licensing agreement and that whether Mallinckrodt survives is an open question ); David McGowan, Reading Quanta Narrowly, Patently-O (July 27, 2008), (arguing that Quanta did not address conditional licenses or pass-through conditions and therefore does not undercut Mallinckrodt); Shubha Ghosh, The Quandry of Quanta: Thoughts on the Supreme Court Decision One Week Later, Antitrust & Competition Policy Blog (June 17, 2008), (discussing whether Quanta undercuts Mallinckrodt or whether the cases can be read as consistent with each other); Robert W. Gomulkeiwicz, The Federal Circuit s Licensing Law Jurisprudence: Its Nature and Influence, WASH L. REV. (forthcoming 2009), available at (stating that Quanta actually affirms the Mallinckrodt line of cases on the conditional sale doctrine); Steven Z. Szczepanski, Updated by David M. Epstein, 2 ECKSTROM S LICENSING IN FOREIGN & DOMESTIC OPERATIONS 8:22 (Thomson Reuters West 2008) (calling Quanta an affirmation of the conditional sale doctrine).

8 2954 CARDOZO LAW REVIEW [Vol. 30:6 patentee can never avoid exhaustion via a conditional sale. 39 On the other hand, the Quanta opinion can be read more narrowly as only holding that the LGE-Intel agreement before the Court was not a conditional sale, 40 while reserving the decision as to whether patent rights may be preserved by other types of agreements. 41 Part I of this Note begins by tracing the evolution of the exhaustion and conditional sale doctrines through the case law. Part I also describes the Quanta litigation and the Supreme Court s treatment of the case. Part II disputes the contention that there is a conflict between the exhaustion and conditional sale doctrines. It describes how the two doctrines may be read as consistent with each other and why preserving the conditional sale doctrine is desirable. Part III proposes an exhaustion analysis that incorporates principles from both Quanta and Mallinckrodt v. Medipart, the leading Federal Circuit case on the conditional sale doctrine. It also makes some observations and suggestions about structuring patent licensing agreements after Quanta. I. HISTORY OF THE EXHAUSTION AND CONDITIONAL SALE DOCTRINES A. The Supreme Court s Exhaustion Doctrine A patentee may bring an infringement suit 42 to prevent another 43 from making, using, selling, or offering to sell a patented invention, 44 and can recover damages for infringing activities. 45 In response, the alleged infringer may, inter alia, defend her actions based on the theory that an earlier authorized sale of the patented article, whether by the patentee or her authorized licensee, terminated all patent rights with respect to that item. 46 The exhaustion doctrine first arose in a series of nineteenth-century patent infringement cases addressed by the Supreme Court. In Bloomer v. McQuewan, 47 the assignee 48 of patent rights to make and sell the 39 See, e.g., Holman, supra note See infra Parts I.C.ii and III.B. 41 E.g., McGowan, supra note U.S.C. 281 (2006) U.S.C. 283 (2006) U.S.C. 271(a) (2006) U.S.C. 284 (2006). 46 E.g., U.S. v. Univis Lens Co., 316 U.S. 241 (1942); Adams v. Burke, 84 U.S. (17 Wall.) 453 (1873); Bloomer v. McQuewan, 55 U.S. (14 How.) 539 (1852); CHISUM, supra note 15, at 16.03(2)(a) U.S. 539 (1852). 48 At the time, assignment was governed by R.S See Keeler v. Standard Folding Bed Co., 157 U.S. 659, 661 (1894) ( [E]very patent or any interest therein shall be assignable in law by an instrument in writing, and the patentee and his assigns or legal representatives may in like

9 2009] EXHAUSTION AND CONDITIONAL SALE 2955 Woodworth planing machine 49 during an extension of the patent term 50 sued a prior purchaser from the patentee for infringement. 51 The assignee claimed that the purchaser infringed on his exclusive right by using the two previously purchased machines during the extended term. 52 The Court held that the first sale by the patentee removed the purchaser s machines from the patent monopoly 53 and therefore exhausted the right of the patentee, or his assignee, to sue for infringement. 54 Shortly thereafter, in Adams v. Burke, 55 the Supreme Court explained that the exhaustion doctrine is premised on the idea that the patentee receives just compensation for disclosure of his invention from the first authorized sale. 56 Adams and Keeler v. Standard Folding manner grant and convey an exclusive right under his patent to the whole or any specified part of the United States. ). It was often the case that the patentee divided the territory of the United States into twenty or more specified parts through assignments. Id. at 662; see also CHISUM, supra note 15 at 19.04(3)(h) ( It is generally assumed that a patent owner may assign or license the right to practice the invention on a territorially restricted basis. ). 49 A planing machine is a machine for smoothing or shaping wood. WEBSTER S THIRD NEW INTERNATIONAL DICTIONARY (Philip Babcock Gove, Ph.D., ed., G. & C. Merriam Co., 1976) (1961). 50 The Patent Act of 1836 allowed a patentee to obtain a seven-year extension of the original fourteen-year patent term upon a showing that such an extension was necessary for the patentee to obtain reasonable remuneration for his investment in the invention. Patent Act of 1836, ch. 306, 18, 5 Stat. 117, Such renewal extended to assignees and grantees of the patent. Bloomer, 55 U.S. at 549. In 1861, Congress abolished the extension system and adopted a uniform seventeen-year patent term. Act of March 2, 1861, ch. 137, 16, 12 Stat. 246, 249; C. Michael White, Why a Seventeen Year Patent?, 38 J. PAT. OFF. SOC Y 839 (1956). In 1994, Congress enacted the current twenty-years-from-filing patent term. 35 U.S.C. 154(a)(2) (2006); H.R. REP. NO (I), at 8 (1994), reprinted in 1994 U.S.C.C.A.N U.S. at 548. Purchaser McQuewan bought from the patentee Woodworth the right to make and use two patented wood planing machines within the Pittsburgh area. Id. Subsequently, assignee Bloomer obtained the exclusive right to construct and use the patented machine in the greater Pittsburgh area during an extension of the patent term. Id. 52 Id. 53 Id. at 549 ( [W]hen the machine passes to the hands of the purchaser, it is no longer within the limits of the monopoly. It passes outside of it, and is no longer under the protection of the act of Congress. ). 54 Id. at The court distinguished between a licensee of the rights to manufacture and sell the patented invention, who buys with respect to the patent term, and a purchaser of the right to use the machine. Id. at 549 ( But the purchaser of the implement or machine for the purpose of using it in the ordinary pursuits of life, stands on different ground. ) U.S. (17 Wall.) 453 (1873). Lockhart & Steelye obtained the right to make and sell patented coffin lids within a ten-mile radius of Boston (the Boston circle ), while Adams obtained a similar right to make and sell the coffin lids outside the Boston circle. 84 U.S. at 454. Burke, an undertaker, purchased a coffin-lid from Lockhart & Steelye within the Boston circle, but then used it to bury a body within Adams territory. Id. The Court found that Adams (an assignee) could not maintain an infringement suit against Burke (a purchaser) because Burke s purchase from authorized sellers in Boston exhausted all patent rights with respect to the coffin lid in any territory. Id. at Id. at 456 ( [W]hen the patentee, or the person having his rights, sells a machine or instrument whose sole value is in its use, he receives the consideration for its use and he parts with the right to restrict that use. ); see also Bloomer v. Millinger, 68 U.S. 340, 350 (1863) ( [Patentees] are entitled to but one royalty for a patented machine, and consequently when a patentee has himself constructed the machine and sold it, or authorized another to construct and

10 2956 CARDOZO LAW REVIEW [Vol. 30:6 Bed 57 also illustrated that a purchaser obtained the right to use 58 and to resell 59 the patented invention free and clear of geographic restrictions limiting the rights of the assignee seller. Construing the Sherman Antitrust Act and Clayton Act in the late nineteenth and early twentieth centuries, 60 the Court also defined some limits on the types of restricted sales and tiered licensing agreements sell it, or to construct and use and operate it, and the consideration has been paid to him for the right, he has then to that extent parted with his monopoly, and ceased to have any interest whatever in the machine so sold or so authorized to be constructed and operated. ); William P. Skladony, Commentary on Select Patent Exhaustion Principles in Light of the LG Electronics Case, 47 IDEA 235, 238 (2007) ( [W]ith respect to the conveyance of an article, the patent exhaustion doctrine is based on a fundamental notion that the patent owner gets only one bite at the apple. ). Other rationales for the exhaustion doctrine include (1) the historical dislike of restraints on alienation or servitudes on personal property, (2) an ownership interest rationale, (3) concerns about anticompetitive effects, and (4) enforcing the scope of the statutory patent grant. See Brief of Various Law Professors as Amici Curiae in Support of Respondent at 3, Quanta Computer, Inc. v. LG Elec.s, Inc., 128 S.Ct (2008) (No ) [hereinafter Brief of Various Law Professors] (noting the law s skepticism towards restrictive servitudes as well as the general understanding that no servitudes run with the sale of ordinary chattels ); id. at & n.4; Michael A. Carrier, Cabining Intellectual Property Through a Property Paradigm, 54 DUKE L.J. 1, 115 (2004) (analogizing the patent exhaustion doctrine to the common law prohibition of restraints on alienation); William A. Birdwell, Exhaustion of Rights and Patent Licensing Market Restrictions, 60 J. PAT. OFF. SOC Y 203, , 216 (1978) (stating that the best rationale for the exhaustion doctrine is that since the exclusive patent right is a limited exception to the national competition policy... the exercise of this right should be cut off after the first sale of the patented goods because the sale provides adequate financial reward to stimulate invention.... ); John W. Osborne, Justice Breyer s Bicycle and the Ignored Elephant of Patent Exhaustion: An Avoidable Collision in Quanta v. LGE, 7 J. MARSHALL REV. INTELL. PROP. L. 245, 293 (2008) [hereinafter Justice Breyer s Bicycle] (noting that patent exhaustion is reflective of the scope of patent rights granted by statute ) U.S. 659 (1895). The inventor of an improvement in wardrobe bedsteads assigned his patent rights to various parties in different geographic regions. Id. at 659. Keeler & Bros. purchased wardrobes from the Michigan assignee and resold the wardrobes in Massachusetts. Id. The Supreme Court held that the Massachusetts assignee could not sue purchaser Keeler for patent infringement because patent rights were exhausted by the authorized sale from the Michigan assignee. Id. at 662 ( [T]he purchaser of a patented machine has not only the right to continue the use of the machine so long as it exists, but to sell such machine, and that his vendee takes the right to use. ). The court reasoned, [W]hen the royalty has once been paid to a party entitled to receive it, the patented article then becomes the absolute, unrestricted property of the purchaser, with the right to sell it as an essential incident of such ownership. Id. at 664. The Court left open the possibility that the patentee might protect himself and his assignees by contracting directly with the purchaser. Id. at 666 ( Whether a patentee may protect himself and his assignees by special contracts brought home to the purchasers is not a question before us, and upon which we express no opinion. ). 58 E.g., Bloomer v. McQuewan, 55 U.S. 539 (1853); Adams v. Burke, 84 U.S. 453 (1873). 59 Keeler, 157 U.S. at 661 ( [I]t is obvious that a purchaser can use the article in any part of the United States, and, unless restrained by contract with the patentee, can sell or dispose of the same. ). 60 For a brief history of the relationship between antitrust and intellectual property laws, see Herbert Hovenkamp, Innovation and the Domain of Competition Policy, 60 ALA. L. REV. 103, (2008). For a thorough treatment of the antitrust-intellectual property relationship, see HERBERT HOVENKAMP, IP AND ANTITRUST: AN ANALYSIS OF ANTITRUST PRINCIPLES APPLIED TO INTELLECTUAL PROPERTY LAW (2002).

11 2009] EXHAUSTION AND CONDITIONAL SALE 2957 patentees could enforce. 61 At issue in Bauer & Cie v. O Donnell 62 was whether a patentee could enforce vertical price restraints, 63 which it included in a licensing contract and on a label license, 64 via a patent infringement suit against a purchaser from its licensee. The patentee argued that its patent rights survived the authorized sale from a licensed refinery to a jobber 65 because the product s label stated a minimum resale price. 66 The Court found that the sale from the licensee to the jobber exhausted the patentee s rights 67 and that the patent statute did not authorize the patentee to set the price of transactions beyond the initial authorized sale. 68 Subsequently, the Court relied on the patent exhaustion doctrine to 61 After the passage of the Sherman Act in 1890, several antitrust cases involving the sale of patented articles presented opportunities for the Supreme Court to revisit the patent exhaustion doctrine. See William A. Birdwell, Exhaustion of Rights and Patent Licensing Market Restrictions, 60 J. PAT. OFF. SOC Y 203, 203 (1978) ( In addition to barring a patent infringement action to prevent the purchaser of patented goods from using or disposing of those goods as he chooses, this principle [the exhaustion doctrine] has been applied also to find contractual restraints on the use or disposition of such goods by their purchaser illegal under antitrust law. ). Prior to these cases, the Supreme Court had declined to decide whether a patentee could place express restrictions or conditions on the sale of patented goods, saying that the patentee could exert any desired control through licenses or assignments to manufacturers. Morris, supra note 17 at 1579 n.115; Hobbie v. Jennison, 149 U.S. 355, 363 (1893) ( It is easy for a patentee to protect himself and his assignees.... He can take care to bind every licensee or assignee, if he gives him the right to sell articles made under the patent, by imposing conditions which will prevent any other licensee or assignee from being interfered with. ) U.S. 1 (1913). 63 A vertical price restraint is price-fixing among parties in the same chain of distribution, such as manufacturers and retailers, attempting to control an item s resale price. BLACK S LAW DICTIONARY 853 (8th ed. 2004). At the time of the Bauer decision, vertical price restraints were considered per se illegal. Bauer & Cie, 229 U.S. at (citing Dr. Miles Med. Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911), overruled by Leegin Creative Leather Prods. v. PSKS, Inc., 127 S. Ct. 270 (2007)). 64 A label license is a notice on an item s package granting the purchaser a license to practice the process by using the item without additional payments to the licensor. BLACK S LAW DICTIONARY 939 (8th ed. 2004). 65 A jobber is one who buys from a manufacturer and sells to a retailer; a wholesaler or middleman. BLACK S LAW DICTIONARY 853 (8th ed. 2004). 66 The product s label included a Notice to Retailer stating that the retail price was to be no less than one dollar, that anyone who sold the product for less than that amount would be liable to an injunction and damages (the typical remedies for patent infringement), and that purchase of the item was acceptance of these conditions. 229 U.S. at 8-9. The object of the notice is said to be to effectually maintain prices and to prevent ruinous competition by the cutting of prices in sales of the patented article. Id. at 11. Retailer O Donnell sold the article for less than the one-dollar minimum price set by the patentee, so the Bauer Chemical Company refused to supply him with additional product. Id. at 9. When O Donnell subsequently purchased the article from a jobber and resold it for less than one dollar, patentees Bauer & Cie sued him for patent infringement. 67 Id. at Id. ( The right to vend conferred by the patent law has been exercised, and the added restriction is beyond the protection and purpose of the act. ). The Court reasoned by analogizing to the exhaustion doctrine in copyright law. See Bobbs-Merrill v. Straus, 210 U.S. 339 (1908) (holding that the first authorized sale of a copyrighted work exhausted rights under the copyright statute). For an overview of the exhaustion doctrine in copyright law, see MELVILLE B. NIMMER, NIMMER ON COPYRIGHT 8.12 (Matthew Bender 2008).

12 2958 CARDOZO LAW REVIEW [Vol. 30:6 conclude that patentees could not tie 69 the sale of unpatented articles to the use of patented ones. 70 For example, the Court held that the patent laws did not permit a patentee to require purchasers of its patented movie projectors also to purchase its unpatented films or risk infringement for using the projector with another manufacturer s film. 71 The Court also applied the exhaustion doctrine, along with the Sherman Antitrust Act, to strike down an anticompetitive tiered licensing arrangement for the sale of a patented gasoline. 72 The patentee attempted to control the parties to and prices of all sales of gasoline containing its patented additive. 73 The Court held that the patentee s rights were exhausted by its first sale of the gasoline to the licensed refiners. 74 In its most recent opinion on patent exhaustion prior to Quanta, the Supreme Court set forth a two-prong test for patent exhaustion. At issue in United States v. Univis Lens Co. 75 was whether the authorized 69 See BLACK S LAW DICTIONARY 1557 (8th ed. 2004) (defining a tying arrangement as [a] seller s agreement to sell one product or service only if the buyer also buys a different product or service.... Tying arrangements may be illegal under the Sherman or Clayton Act if their effect is too anticompetitive. ). 70 Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502 (1917). Motion Picture Patents ( MPP ) owned patent rights directed toward a film-feeding mechanism used in motion picture projectors. Id. at 505. MPP required its manufacturing licensee Precision Machine Company to sell the projectors with an attached plaque that stated the projector could only be used with film that was also licensed by MPP. Id. at MPP brought a patent infringement suit against a purchaser of one of the projectors, and against rival film-maker Universal, after its patent directed toward the film technology had expired. Id. at The Supreme Court held that, since MPP had market power with respect to the projectors, such a tying restriction was illegal. Id. at 508 (finding market power): Such a restriction is invalid because such a film is obviously not any part of the invention of the patent in suit; because it is an attempt, without statutory warrant, to continue the patent monopoly in this particular character of film after it has expired, and because to enforce it would be to create a monopoly in the manufacture and use of moving picture films, wholly outside of the patent in suit and of the patent law as we have interpreted it. Id. at Ethyl Gasoline Corp. v. United States, 309 U.S. 436 (1940). Ethyl Corporation owned patents directed toward the use of a gasoline additive. Id. at 446. The patentee derived its profits from the sale of the patented fluid to licensed oil refiners, but also instituted a licensing scheme to control the subsequent sale of the gasoline from the refiners to jobbers. Id. at 446, In an antitrust suit brought by the government, the Court found that this licensing arrangement was an impermissible attempt to enlarge Ethyl s monopoly and struck it down under the Sherman Act. Id. at Id. at The Court reasoned that Ethyl s sale of the patented fuel to refiners exhausted its patent rights, and therefore Ethyl could not control the refiner s sale of the fuel to jobbers under either patent or contract law. Id. at U.S. 241 (1942). Univis owned several patents directed toward the shape, size, and composition of pieces of glass of different refractive power fused together to create multifocal ophthalmic lenses. Id. at The patentee instituted a tiered licensing scheme in which it granted licenses to wholesalers, finishing retailers, and prescription retailers that set forth from whom the licensees could buy unfinished lens blanks, to whom the licensees could sell the lenses they finished, and at what prices each licensee was to sell its products. Id. at Univis

13 2009] EXHAUSTION AND CONDITIONAL SALE 2959 sale of unpatented lens blanks 76 could exhaust the patentee s rights with the regard to the patented finished lenses that were produced from the blanks. The Court held that the sale of the blanks triggered exhaustion. 77 This decision expanded the scope of the exhaustion doctrine by holding that the authorized sale of unpatented articles 78 could exhaust patent rights if the articles sold (1) embodied the essential features of the patents, and (2) had no utility other than to practice the patents. 79 Thus, the exhaustion doctrine terminates the right of a patentee to sue a purchaser for infringement when that purchaser has already paid a fair price to use, repair, and resell the article. Application of the doctrine requires a determination of whether there has been an unconditional and authorized sale of an article embodying the essential inventive features of the patent. Where such sale has occurred, the article has been removed from the patent monopoly and cannot be the subject of an infringement suit. B. The Federal Circuit s Conditional Sale Doctrine The conditional sale doctrine developed simultaneously with the exhaustion doctrine, albeit with less guidance from the Supreme Court. While an authorized and unconditional sale exhausts the patentee s argued its patent monopoly was a defense to the government s antitrust claims. Id. at The lens blanks at issue were rough opaque pieces of glass of suitable size, design and composition for use, when ground and polished, as multifocal lenses in eyeglasses. Id. at Id. at Sale of a lens blank by the patentee or by his licensee is thus in itself both a complete transfer of ownership of the blank, which is within the protection of the patent law, and a license to practice the final stage of the patent procedure. In the present case the entire consideration and compensation for both is the purchase price paid by the finishing licensee to the Lens Company. 78 Licensed wholesalers sold unfinished lens blanks to licensed retailers, who then finished the lenses and sold the finished products at prices fixed by Univis. Id. at 244. The Court stipulated that Univis s patents were not fully practiced until the blanks were finished, but nonetheless held that Univis could not set prices for the sales by retailers. Id. at [E]ach blank embodies essential features of the patented device and is without utility until it is ground and polished as the finished lens of the patent. Id. at 249. We think that all the considerations which support these results lead to the conclusion that where one has sold an uncompleted article which, because it embodies essential features of his patented invention, is within the protection of his patent, and has destined the article to be finished by the purchaser in conformity to the patent, he has sold his invention so far as it is or may be embodied in that particular article. The reward he was demanded and received is for the article and the invention which it embodies and which his vendee is to practice upon it. Id. at See Wegner, supra note 38, at 685 (describing the Univis decision as plugging a loophole that would have allowed patentees to circumvent the exhaustion doctrine by selling unpatented goods to a purchaser who then finished them into the patented article).