Argument Preview: Quanta v. LG

Sarah Craven, a student in the Supreme Court Litigation Clinic at Stanford University, wrote the following preview of Wednesday’s argument. Find additional links and information at the Quanta v. LG SCOTUSwiki page, here.

Does the licensed sale of components used in a patented invention exhaust patent rights? On January 16, 2008, the Supreme Court will consider the limits of the patent exhaustion doctrine in No. 06-937, Quanta Computer Inc. v. LG Electronics, Inc., a case that could significantly affect patent owners’ ability to claim infringement for subsequent uses of licensed products.

Background

The patent exhaustion doctrine – also known as the first sale doctrine – is a judicially created rule designed to limit a patentee to a single royalty per patented device. The Patent Act grants patent owners the right to exclude others from making, using, offering for sale, or selling any patented invention in the United States. Under patent exhaustion, however, the first unrestricted sale of a patented device terminates a patentee’s control over subsequent uses or sales of that particular device.

The parties do not dispute the basic facts. Respondent LG Electronics, Inc. (LGE) owns a portfolio of patents related to personal computers. LGE sued petitioners, Quanta Computer and numerous other original equipment manufacturers (or OEMs), for infringement, alleging that their combination of Intel microprocessors and chipsets with generic computer components (such as memory and busses) infringed its patents covering computer systems and methods activated by the combination. LGE licensed Intel to sell microprocessors and chipsets to petitioners. This license, however, expressly denied Intel authority to grant third-party licenses and required Intel to notify its customers, including petitioners, that the purchase of Intel chips did not authorize the combination of these products with non-Intel components in a manner that infringed LGE’s patents.

Relying on patent exhaustion, the district court granted petitioners partial summary judgment on LGE’s infringement claim. In its first order, the court held that because Intel’s chips had no reasonable noninfringing use, LGE’s license to Intel and Intel’s subsequent sale to petitioners exhausted LGE’s patent rights to such uses. On reconsideration, however, the court backtracked, holding that although LGE may impose conditions on the sale of essential components of its patented inventions, it had not done so here. Specifically, the evidence failed to demonstrate that petitioners agreed to the notice conditions from Intel that withheld authority to combine Intel chips in an infringing manner, and therefore petitioners’ purchase from Intel constituted an unconditional sale, triggering patent exhaustion. The court, however, held that this exhaustion applied only to LGE’s system claims; the doctrine of patent exhaustion does not apply to method claims as a matter of law.

On appeal, the Federal Circuit affirmed as to the method claims but reversed the district court’s holding that exhaustion applied to LGE’s system claims. The court of appeals held that neither the license to Intel nor the sale to petitioners amounted to an unconditional sale that triggered patent exhaustion. The court reached this conclusion based on the LGE-Intel license expressly prohibiting Intel’s customers from infringing LGE’s combination patents, invoking the UCC to suggest a contractual agreement by petitioners to abide by the license.

Petition for Certiorari

Quanta and the other original equipment manufacturers filed a petition for certiorari, which the Supreme Court granted on September 25, 2007.

Petitioners’ argument is straightforward: Supreme Court patent exhaustion decisions, the most recent of which was decided over a half-century ago, establish that when Intel sold them microprocessors and chipsets under an unrestricted license from LGE, LGE exhausted its right to control their only reasonable use of such chips. The Federal Circuit’s contrary holding, petitioners argue, demonstrates an evisceration of the Court’s exhaustion jurisprudence, with the court of appeals invoking contract law to render patent exhaustion optional, nullified simply by “notice” from the patent owner that the doctrine does not apply. Petitioners suggest that, absent the Court’s intervention, a parade of horribles will occur: “[T]he Federal Circuit’s new jurisprudence of ‘notice’ restriction threatens to usher in a new era of servitudes and restraints on alienation running with chattel.” This, petitioners claim, will result in a dangerous expansion of the patent monopoly, allowing patent owners to suppress competition by controlling the use of patented goods after an authorized first sale. LGE’s suit represents this dangerous new era, petitioners charge, for after receiving royalties from Intel, LGE now seeks to shake down the entire computer industry for billions of dollars in duplicative licensing fees.

In its brief in opposition, LGE counters that this case represents nothing more than an infrequent and case-specific application of Supreme Court precedent, uncontested by petitioners, that a patentee may restrict its licensees’ sales to downstream customers. Specifically, LGE argues that the LGE-Intel license only granted Intel authority to practice LGE’s patents but expressly did not grant Intel any right to convey such authority to its customers. Instead, LGE required Intel to send notice to its customers, including petitioners, that the sale of Intel microprocessors and chipsets did not authorize the combination of these components with non-Intel parts in a manner that infringed LGE’s patents. LGE, therefore, frames Intel’s sales to petitioners as conditional sales under the LGE-Intel license, and conditional sales fail to trigger patent exhaustion. LGE concludes that because the lower courts simply disagreed about whether the transactions here were sufficiently conditional, certiorari should be denied.

Merits Briefing

In their brief on the merits, petitioners repeat and expand on the argument advanced in the petition for certiorari: Intel’s authorized and unrestricted sale of microprocessors and chipsets to petitioners exhausted LGE’s control over the only reasonable use of those chips under patent law. Petitioners advance a barrage of arguments, attacking the Federal Circuit’s exhaustion jurisprudence as a “confusing mélange” of patent, antitrust, and contract principles and asking the Court to restore order by reasserting the Court’s exhaustion doctrine.

Petitioners first attack the Federal Circuit’s reliance on LGE’s intent as relevant to the doctrine of patent exhaustion. The court of appeals held that LGE’s intent not to convey a license to Intel’s customers established Intel’s sale to petitioners as conditional and thus as failing to trigger exhaustion. Petitioners argue this holding conflates exhaustion with the separate doctrine of “implied license” and suggests that exhaustion amounts to nothing more than a default presumption absent contractual provisions to the contrary, a notion the Court overruled 90 years ago.

Second, petitioners distinguish the facts here from the Court’s precedents holding that conditions may be imposed on manufacturing licensees, thus countering the heart of LGE’s argument in its opposition brief to certiorari. Petitioners acknowledge that a patent owner may restrict the terms under which licensees are authorized to make, use, and sell a patented product and that sales in violation of such restrictions amount to unauthorized sale that do not trigger exhaustion. Here, however, LGE imposed, not restrictions on sales by its licensee Intel, but restrictions on the use of purchased products by third parties after an authorized sale and thus after triggering patent exhaustion.

Third, petitioners attack the Federal Circuit’s exhaustion jurisprudence more generally as treating exhaustion as nothing more than a type of antitrust or patent misuse law. Petitioners argue that by analyzing exhaustion doctrine under the rubric of whether the patentee has acted beyond the patent grant to anticompetitive effect, the court of appeals misreads Supreme Court precedent and, in abandoning the Court’s bright-line rule in which exhaustion limits the scope of the patent grant, adopts a test that imposes no meaningful limitations at all.

Petitioners next argue that patent exhaustion must cover the sale of components with no reasonable non-infringing use as well as method claims practiced by such infringing use. Petitioners suggest that if exhaustion is not so interpreted, patentees could eradicate the doctrine either by authorizing all but the final step in assembly down a distribution chain or by including a method claim covering the intended use of the completed device.

Finally, petitioners ask the Court not to reconsider patent exhaustion anew but to adhere to the Court’s traditional exhaustion doctrine to overrule the Federal Circuit. Petitioners first argue that any change in the traditional rule should come from Congress, which reenacted the patent laws in 1952 in light of and without modifying the Court’s exhaustion doctrine. Petitioners next argue that sound public policy and economic analysis support the Court’s traditional exhaustion rule as it follows traditional property rules in disfavoring post-sale restrictions on personal property and greatly reduces transaction costs along a distribution chain without reducing a patentee’s reward. Acknowledging that LGE could have conditioned its license to Intel on sales to purchasers with a license, and thus the dispute in part turns on the agreement’s form, petitioners argue that the form has legal consequences: one permits freedom of contract while the other hands to patent owners the unprecedented power to redefine the scope of the patent grant.

In its brief on the merits, LGE advances three arguments why Intel’s licensed sale of microprocessors and chipsets to petitioners did not exhaust LGE’s patent rights. First, LGE argues that the sale of patented components—here, the sale of chips by Intel—may exhaust patent rights in the purchased components but cannot exhaust rights in distinct patented inventions—here, the computer systems and methods infringed by combining Intel chips with generic computer components. This interpretation of exhaustion doctrine comports with the fact that the sale of a patented device exhausts only some of a patentee’s rights: the right to control the “use” and “sale” of the purchased device but not the right to “make” the device anew. As such, the sale of a patented device cannot exhaust the right to “make” an entirely different patented invention even if that invention incorporates the purchased device. Petitioners, LGE contends, propose not a return to traditional exhaustion doctrine but an extension of the doctrine to separately issued patents that has no basis in Supreme Court precedents. This extension, LGE continues, will have harmful market effects: It will require manufacturing licensees to pay the full value of the rights to all combinations to which the licensed component could be used rather than allowing the patent owner to split the cost among downstream purchasers who seek to practice distinct inventions. This will undermine the statutory grant of separate patent rights for novel and non-obvious combination inventions and, ultimately, stifle innovation as inventors will no longer be assured of a reasonable return on their investment in invention.

Second, LGE reformulates the argument from its brief in opposition to certiorari: patent owners may impose reasonable conditions on their licensees’ sales. LGE frames the condition imposed here not as a restriction on the “use” or “sale” of the components sold by Intel, but on the “making” of the patented systems. Thus, even if the sale of chips by Intel did constitute the sale of LGE’s separately patented computer systems, LGE reasonably conditioned the sale to exclude the “making” of these systems by combining Intel chips with generic computer components as exhaustion does not apply to the right to “make” a patented invention.

Finally, LGE argues that the exhaustion doctrine, even if applicable to its system claims, does not apply to its method claims. Specifically, LGE contends that rights in a patented device may be exhausted because those rights are linked to a tangible article whose economic value derives from its manufacture. But the same is not true of a patented method, whose sole economic value lies in its “use,” and such use can never be exhausted by a sale.