Quanta Computer, Inc. v. LG Electronics, Inc.

Quanta Computer, Inc. v. LG Electronics, Inc. is a 2008 decision of the U.S. Supreme Court in which the Court reaffirmed the validity of the patent exhaustion doctrine, and checked a line of decisions in the Federal Circuit that had treated the doctrine as outmoded. Beginning with Mallinckrodt, Inc. v. Medipart, Inc., the Federal Circuit had held that patent owners could sell patented goods with a restrictive notice and thereby restrict the disposition of the goods by the purchasers, with the sole exception of price-fixing and tie-in restrictions. In Quanta, however, the Court held that “[t]he longstanding doctrine of patent exhaustion provides that the initial authorized sale of a patented item terminates all patent rights to that item.” Subject to some possible caveats, the effect was to restore the law to its pre-Mallinckrodt state.

Factual background

LG Electronics (LGE) owned several patents on methods and systems for processing information. It entered into two contracts with Intel. In the License Agreement, LGE authorized Intel to make and sell microprocessor products using the patented inventions. Moreover, the License Agreement expressly stated that no license was granted to any third party for combining licensed products with other products (for example, for combining Intel microprocessor products with other parts of a computer). The License Agreement also provided, however, “Notwithstanding anything to the contrary contained in this Agreement, the parties agree that nothing herein shall in any way limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products.”

In the Master Agreement, LGE required Intel to give its customers notice that the patent license does not extend to any product made by combining a licensed Intel microprocessor product with any other product (for example, a computer containing the Intel microprocessor products). The Master Agreement also provided that its breach would have no effect on the License Agreement and would not be grounds for its termination. Apparently, LGE was willing to allow Intel’s customers to combine the microprocessor products with products not licensed by LGE, but only upon payment of a further royalty to LGE for the right to do so. This point is not discussed in the Court’s opinion, which recites the facts only in very limited terms because the record was under seal to protect trade secrets.

Quanta purchased licensed Intel microprocessor products and proceeded to manufacture computers containing them. In doing so, Quanta followed Intel’s specifications, which in turn led to practice of the patented methods and making the patented systems that LGE licensed to Intel––since that was the way Intel had designed its microprocessor products. (The trial court found that the Intel microprocessor products were without any reasonable noninfringing use.) LGE then sued Quanta for patent infringement.

Quanta prevailed in the district court under the exhaustion doctrine, but on appeal the Federal Circuit held that the exhaustion doctrine did not apply because of the statement in the Master Agreement that combination products were not licensed, and additionally the Federal Circuit held that the exhaustion doctrine did not apply to method patents.

Supreme Court opinion

The Supreme Court unanimously reversed, in an opinion by Justice Thomas.

Method claims

First, the distinction between method and product claims is insupportable. In United States v. Univis Lens Co., the most recent decision of the Court on exhaustion, some of the patents held exhausted were method patents. Earlier, in Ethyl Gasoline Corp. v. United States, some patents covered a method of combusting gasoline in an automobile engine––and the exhaustion doctrine was held applicable. Furthermore, because it is easy to write patent claims for the same invention either in method format or apparatus format, the exhaustion doctrine could easily be evaded if reliance on method claims was sufficient to avoid exhaustion: By “including a method claim for the machine’s patented method of performing its task, a patent drafter could shield practically any patented item from exhaustion.”

Exhaustion and related patents

The Court then turned to the extent, if any, to which exhaustion of the patent rights on the microprocessor products exhausted patent rights relating to the combination products on which LGE had patents. In the Univis case the sale that exhausted patent rights was a sale of an unpatented semifinished lens blank, which subsequent processing turned into a patented finished lens. The Intel microprocessor products were finished commercial articles of commerce, but in this case the trial court had found as a fact that the microprocessor products had no noninfringing use, just as in the Univis case the semifinished lens blanks had no use but to be finished into the patented finished lens blanks. Therefore, the Court found Univis dispositive. In the Quanta Court’s language, in Univis “exhaustion was triggered by the sale of the lens blanks because their only reasonable and intended use was to practice the patent and because they ‘embodie[d] essential features of [the] patented invention.’”

LGE did not challenge the claim that the intended and reasonable use of the microprocessor products was to incorporate them into computers, but it claimed that some noninfringing uses existed: they could be sold overseas, as repair parts, or by disabling the features that made them patented. The Court dismissed these arguments. As for disablement, the Court asserted that the disabled device aspects (“features”) rather than the device that remained must have a noninfringing use, so that disabling them would cause them to have “no real use.” As for foreign or replacement use, the legal test to be looked to was whether the product would perform the patented method or embody the patented product, not whether the use gave rise to infringement liability.

A further reason why sales of the microprocessor products exhausted LGE’s patent rights was that “everything inventive about each patent is embodied in” the licensed Intel products, which “embody the essential features of the [licensed] patents because they carry out all the inventive processes when combined, according to their design, with standard components.” Any point of novelty—that is, respect in which the claimed invention departs from the prior art—is found in the licensed microprocessor products rather than in the combination product of which they are components.

Licensing a limited field

LGE’s argument for non-exhaustion sought to invoke the doctrine of General Talking Pictures Corp. v. Western Electric Co. In that case, the patentee had granted no license for “commercial” amplifiers. Therefore, when a manufacturer licensed only in the “non-commercial” field of use sold an amplifier to an accused infringer, who knowingly resold it in the commercial market, the manufacturer “could not convey to [the accused infringer] what both knew it was not authorized to sell.” By parity of reasoning, LGE said, it had licensed Intel only in the field of manufacturing microprocessor products for combination with specified products and not with other products. But the Court said that was not how LGE had drafted its license to Intel:

LGE overlooks important aspects of the structure of the…transaction. Nothing in the License Agreement restricts Intel’s right to sell its microprocessors…to purchasers who intend to combine them with non-Intel parts. It broadly permits Intel to make, use, or sell products free of the patent claims. To be sure, LGE did require Intel to give notice to its customers, including Quanta, that LGE had not licensed those customers to practice its patents. But neither party contends that Intel breached the agreement in that respect.

LGE points out that the License Agreement specifically disclaimed any license to third parties to practice the patents by combining licensed products with other components. But the question whether third parties received implied licenses is irrelevant because Quanta asserts its right to practice the patents based not on implied license but on exhaustion. And exhaustion turns only on Intel’s own license to sell products practicing the…patents.

The Court appears to be saying that LGE simply licensed Intel to make, use, and sell microprocessor products. LGE expressly stated that no license was granted to any third party for combining licensed products with other products; and LGE made Intel tell its customers about the absence of a license. But LGE did not say to Intel that LGE licensed Intel to make, use, and sell microprocessor products only in the field of microprocessor products combined with other LGE-licensed products (so-called Intel products). There was no explicit field-of-use limitation on Intel’s manufacturing, using, and selling rights––no “magic words.” LGE came close––it said it was not licensing third parties to combine licensed product with other products, and it required Intel to notify customers of that––but LGE failed to go right to the point and expressly deny Intel any license to make microprocessor products that would be combined with other products. Furthermore, for some inexplicable reason the parties, with fatal effect, red-flagged the fact that there still was an exhaustion doctrine: “Notwithstanding anything to the contrary contained in this Agreement, the parties agree that nothing herein shall in any way limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products.”

That this was a critical error (for LGE) is confirmed by the Court’s final statements in its opinion:

The License Agreement authorized Intel to sell products that practiced the patents. No conditions limited Intel’s authority to sell products substantially embodying the patents. …Intel’s authorized sale to Quanta thus took its products outside the scope of the patent monopoly, and as a result, LGE can no longer assert its patent rights against Quanta.

Thus, the exhaustion doctrine governed what Quanta could lawfully do with what it bought from Intel. The failure to give third parties a license to combine Intel microprocessor product with other products had no legal significance, because the exhaustion doctrine obviated any need for such a license. Having bought the products from an authorized seller, Quanta didn't need any license.

No contract issue

Just before closing, the Court added a final note pointing out that the case did not raise, and the Court did not rule on, whether LGE could have enforced a contractual restriction. In footnote 7, the Court commented:

We note that the authorized nature of the sale to Quanta does not necessarily limit LGE’s other contract rights. LGE’s complaint does not include a breach-of-contract claim, and we express no opinion on whether contract damages might be available even though exhaustion operates to eliminate patent damages.

By the same token, the Court said nothing as to specific performance or whether contract rights, if any, could be enforced against Quanta.

Impact and issues that the court did not consider

The impact of Quanta is problematic, largely because the decision avoided deciding many issues, presumably in the interest of maintaining consensus. (The decision was unanimous.) One academic commented:

It is a very disappointing decision from the Court. It decided so little, and it was such an important case. You are left reading tea leaves.

The Court's failure to approve or reject the precedent on which the Federal Circuit had relied in its decision in Quanta, Mallinckrodt, Inc. v. Medipart, Inc., which had limited the applicability of the exhaustion doctrine when a sale was made "conditional," further contributed to business uncertainty about permissible license restrictions. But, as one commentator observed:

The Supreme Court, in Quanta, was widely expected to rule on whether Mallinckrodt was good law. But the Court sidestepped the issue by narrowly interpreting the license agreement so that it was not a conditional license. ...Because the Supreme Court sidestepped the issue, it remains unclear to what extent a patentee can use a conditional license to impose restrictions on downstream purchasers.

Other transactional forms

There are a number of important issues that the Court did not address in Quanta. One such omission is the Court’s failure to say anything about the other possible formats that this transaction might have used—such as a sale by a manufacturing licensee with a limitation on its grant, or (alternatively) a sale by the patentee or its licensee with explicit restrictions imposed on the buyer's freedom to dispose of the product. The Court did not explain whether or in what circumstances these other formats would be legally effective.

The first of these possible formats follows the pattern of the General Talking Pictures case. The second format follows the pattern of the Mallinckrodt case. Under the General Talking Pictures doctrine, a patentee may limit the scope of a manufacturer-licensee's license to a defined field--such as microprocessors not incorporated into computers--and then the use of those micropressors as computer components is a patent infringement. This is the format that LGE mistakenly thought it was using. Under the Mallinckrodt doctrine, a sale of a patented product subject to a restriction--such as you must not sell this microprocessor for use as a computer component--is a "conditional," rather than "unconditional," sale. If the condition is violated the conduct is patent infringement. The exhaustion doctrine does not apply under the rule stated in Mallinkrodt. However, as Quanta seemingly holds, when a restriction is not clearly and explicitly stated the exhaustion doctrine applies.

Resolving the "anomaly"

In a brief to the Supreme Court (at its request) when the petition for writ of certiorari was pending, the US Solicitor General observed that a curious "anomaly" existed between the exhaustion doctrine and General Talking Pictures doctrine:

[T]here is a seeming anomaly in allowing a patentee to achieve indirectly –- through an enforceable condition on the licensee –– a limitation on use or resale that [because of the exhaustion doctrine] the patentee could not itself impose on a direct purchaser, [yet] the distinction is a necessary and explicable result of the Court’s decision in General Talking Pictures.

The Government appeared to delete this passage from its subsequent brief on the merits presumably because it recognized that there really is no anomaly once a determination is made as to whether or not the sale is authorized. Thus, the exhaustion doctrine prohibits post-sale restraints on a patentee’s (or its licensee’s) sale of goods when it is found that the sale is authorized, and similarly General Talking Pictures permits a patentee to place post-sale limitations on its manufacturing licensee’s sale of goods if the license to manufacture uses the right, magic words. The Court squarely addressed this in the Quanta decision where it stated the exhaustion doctrine applies only if the sale is authorized. If a sale is in violation of a condition in the license agreement, i.e. the sale is not authorized, then the exhaustion doctrine is not triggered and the patent right is not exhausted. For example, if a patent owner licenses a licensee to "sell only to home use buyers and not commercial buyers," but the licensee sells to commercial buyers anyway, then the licensee violates the condition in the license agreement and the sale is not an authorized sale. Under such circumstances, the patent owner can sue the licensee for contract damages for violating the condition in the license agreement, and/or sue the downstream purchaser that purchased from the licensee for patent infringement.

Can contract trump the exhaustion doctrine?

The Court, in a footnote quoted above (the Court's note 7), expressly refrained from stating any of the following: whether contractual language could overcome, or prevent triggering, the exhaustion doctrine; if so, what language would be effective to do so; and whether the surrounding circumstances would be relevant.

If the policy of the exhaustion doctrine is grounded less in permitting the patent laws to authorize restrictions on the use of purchased goods, and moreso to provide clear notice to third parties (such as Quanta in the Quanta case), particularly unsuspecting third parties, courts may be more likely to place limits on whether parties can by contract make the doctrine inapplicable to the goods that are the subject of their contract. On the other hand, if the policy of the exhaustion doctrine is grounded in providing clear notice to downstream purchasers, while still recognizing that the patent laws authorize restrictions on the use of purchased goods so that parties can by contract define what rights of the patent can appropriately be conveyed, courts may be more likely to uphold such restrictions unless they collide with for example the laws of anticompetition or antitrust.

The Court did not reach this issue in Quanta because it found the language in the LGE-Intel license agreement was insufficient to indicate that the license was conditional. The Quanta court did make clear, however, that it recognized the fundamental difference in law between a sale of patented goods by a patentee and a patentee’s license of another to manufacture the patented goods, which the Supreme Court had explained in United States v. General Electric Co. At the same time, the Court made it clear that LGE had failed to license Intel (the seller to Quanta) in language that invoked the General Talking Pictures doctrine, which could have changed the outcome, as discussed above in the section of this article captioned “Licensing a limited field.”

The House of Lords considered whether contract could trump the similar doctrine against derogation from title in British Leyland Motor Corp. v. Armstrong Patents Co.. This is the doctrine that a seller may not successfully take actions, such as enforcing an intellectual property right, that decrease the value of what the seller has sold to a purchaser. The House of Lords ruled that contract could not be used to lessen the rights of end user purchasers, at least purchasers of consumer products such as motor cars.