Patents Exhausted by Sale after Covenant Not to Sue

TransCore v. Electronic Transaction Consultants (ETC) (Fed. Cir. 2009)

TransCore’s patents cover automated toll collection systems. (Think E-ZPass). The company had previously settlement an infringement suit against a competitor (Mark IV) with a covenant not to sue on the patents. The present lawsuit arose when ETC began installing an automated toll collection system using Mark IV software. The district court dismissed the case – holding that Mark IV’s licensed sales exhausted any patent rights. On appeal, the Federal Circuit affirmed.

In Quanta (2008), the Supreme Court re-affirmed the non-statutory doctrine of patent exhaustion. Exhaustion is triggered by an authorized sale and operates to “terminate all patent rights to that item.”

Covenant versus Authorization: Here, TransCore slyly argued that its covenant not to sue could hardly be equated with an authorized sale sufficient to trigger exhaustion. Of course, a patent holder’s exclusive right is only the right to sue for infringement, and a covenant not to sue gives up all patent rights that could be used in that context. In other words, in the narrow patent context, a covenant not to sue is the functional equivalent to authorizing sales. As the Federal Circuit held in the Spindelfabrik (1987) “a patent license agreement is in essence nothing more than a promise by the licensor not to sue the licensee.”

Scope of Covenant: The license terms specifically focus on Mark IV as a party: “[TransCore] agrees and covenants not to bring any demand, claim, lawsuit, or action against Mark IV for future infringement.” However, the one-party focus does nothing against the exhaustion doctrine because once the software is sold by Mark IV, any patent rights associated with those copies of the software are exhausted. “[T]he district court correctly found that Mark IV’s sales to ISTHA were authorized and that TransCore’s patent rights are exhausted.”

26 thoughts on “Patents Exhausted by Sale after Covenant Not to Sue

  1. I always thought licenses attached to the patent, whereas covenants are personal and attach to the parties. If covenants are licenses, does that mean that they now attach to the patent instead of the parties?

    Case 1 — License: Party A licenses patent to Party B. Party A then sells the patent to Party C. Party C takes the patent subject to the license, and Party B still has freedom of action in view of that patent.

    Case 2 — Covenant: Party A makes a personal promise, from Party A to Party B, that Party A will not sue Party B on the patent. Party A sells patent to party C. If the covenant is a personal promise, and if Party C has made no promise, then Party C can sue Party B on the patent.

    Has this case changed this?

  2. patent license, covenant not to sue, and authorization refer to, substantially, one and the same thing, ie, patentee’s permissions to perform allowed (otherwise infringing acts) acts. All of them can be regulated by way of detailing on specific circumstances, conditions, acts allowed under the permission granted etc. Exhaustion is an extra corollary to the permissions. In view of Quanta (2008), one can always place conditions in order to define whatever one wants to define or restrict, so where is the problem?

  3. My understanding of the patent marking requirement is that it really is meant to apply when the “patented article” is being manufactured and sold under the auspices of the patentee (i.e., “for or under them”). For example, if Nike owned certain patents on athletic shoes and wanted to have shoes manufactured, by third parties, and then imported into and sold in the United States as “Nike” brand shoes, they have to have marked the shoes with the relevant patent numbers.

    However, in the Transcore case, the covenantee (i.e.,Mark IV) was not manufacturing the toll equipment at issue so that it could be sold as “Transcore” toll equipment. Rather, the equipment was manufactured by Mark IV to be sold as “Mark IV” equipment. The covenant therefore was meant to release Mark IV from any future claims based on the sale of “Mark IV” toll equipment, not so that the equipment could be sold as “Transcore” equipment.

    So in light of the above understanding, I don’t see why a covenant not to sue would necessarily trigger the patent marking requirement. If that were true, in a case where a patentee gave a covenant not to sue for past infringing sales, would that now mean that, if those past products had been sold un-marked, the patentee has now lost a potential recovery of damages from some unrelated third-party infringer?

    In addition, patent markings can lead to assertions of false patent marking claims. In that case would the the covenantee, who settled a suit and was required to mark its products with the patentee’s patent numbers, now potentially be subject to a false patent marking claim? Just because the article displays a patent marking does not mean that it is, in good faith and in fact, covered by the claims of the relevant patents. For example, the patentee could have had a very weak case on infringement but sued the covenantee nonetheless. Even though the covenantee would have had a very good defense on infringement, it may have chosen, for business and economic reasons, to settle the action rather than litigate and pay for a covenant and continue selling the same product it got sued on in the first place. If it is now required to mark its product with the patentee’s numbers, could the covenantee now get sued by a third party for a false marking claim? Seems like a lot to ask for in a settlement if the covenantee may be exposed to future claims of false patent marking.

  4. “My reasoning for marking not being triggered by a covenant not to sue. Patent owner offers covenant to avoid or settle suit and includes marking requirement. Defendant says I’ll agree to everything else, but I don’t infringe, no way will I mark. Would patent owner really not settle on the marking issue alone?”

    Alan, with all due respect, I don’t see how that leads you to conclude that a covenant not to sue would not raise a marking issue later. Remember, I am not suggesting that there would be any requirement for the defendant in your scenario to mark. Rather, I am suggesting that it may be a good idea for the patent owner to insist on marking in exchange for granting the covenant. What if instead of a covenant not to sue, the patent owner offers the defendant a license in order to resolve the dispute and the patent owner does not insist on marking? Now, if the patent owner then seeks to enforce the same patent against another, unrelated party, don’t you think that the defendant in that case would raise the issue of marking in order to reduce the potential infringement damages?

    And as for your statement “Would patent owner really not settle on the marking issue alone?,” the converse of that seems equally valid. Would a defendant, particularly one with significant exposure, refuse to settle simply because the patent owner insisted that marking be required as part of the settlement?

  5. I think people are making too much out of the Transcore and Quanta decisions. I don’t think that they impact or dramatically alter patent licensing practice quite as much as people think. Both the Supreme Court and the Federal Circuit have previously held that a bare or naked patent license is nothing more than a promise not to sue. A patent is nothing more than the right to exclude or the right to sue for infringement, and the Patent Act in fact states this. A patentee has no right to make, use, or sell a product covered by the patent. A license therefore can’t convey anything more than a promise not to exercise that right for what would otherwise be infringing conduct by the licensee. So, in this regard, Transcore reveals nothing new nor adds nothing new to established patent jurisprudence. Also, patent exhaustion (also known as the first-sale doctrine) has existed and been applied for decades by courts. In the trademark and copyright contexts it is usually referred to as the first-sale doctrine. So again, neither Transcore nor Quanta really add any new or major doctrine to patent law.

    One of the main overriding purposes of exhaustion or the first-sale doctrine is to make sure that the IP rights holder (or patentee) cannot use its rights to tie up commerce by going after downstream users or purchasers after the IP holder has authorized the first sale. So I think what Quanta and Transcore shed some light on is how to analyze the defense of patent exhaustion.

    It should be kept in mind that the defense of patent exhaustion and the defense of an implied license are two different defenses to a claim for patent infringement each of which calls for a different analysis. What the Supreme Court said in Quanta, now re-affirmed by the Federal Circuit in Transcore, is that to analyze the applicability of the defense of patent exhaustion, you must look to what authority or permission was given to the licensee by the patent holder. If the licensee is authorized to sell (i.e., acting within the scope of its license), then the firs-sale made by the licensee can trigger exhaustion. It is therefore irrelevant what the agreement, covenant, or license says or does not say about what rights or implied licenses are or are not granted to third parties or downstream users. So the statement that a covenant cannot be a license or give rise to an implied license because it is only personal to the covenantee and does not extend to customers is really a non-sequiter. Under the Quanta analysis, the covenant does not have to extend to customers to trigger exhaustion because it only has to protect the seller (i.e., the covenantee). If the covenantee is therefore off the hook from any liability to the patentee, then its sales to its customers have been made with the blessing of the patent holder. It follows that the patent holder has therefore authorized the first-sale and the patent rights are exhausted.

    A covenant not to sue could be different from a license in that it provides no standing to the covenantee to enforce the patent rights. This is often why a covenant not to sue may be used instead of a license. In the case of an exclusive patent license, for example, the licensee could have standing to sue. A covenantee may not, but then again, standing to sue on the patent is not a requirement to trigger exhaustion. Although I think it could be possible to draft an exclusive license using a covenant in which case it could be interpreted as an exclusive license.

    It should also be kept in mind that a covenant can have different scopes. In the Transcore case, it applied to “future infringement.” There was a separate provision releasing for past infringement. Therefore, the covenant was a complete and unconditional relinquishment by the patentee of its right to sue for any “future” infringing acts, namely, the seller’s “future” making, using, selling, or importing of products covered by the patents. The manufacturer had also paid $4.5 million dollars up front for the covenant. So the covenant had every indicia of a fully-paid up non-exclusive license.

    In other contexts, a covenant may not amount to a license that can trigger exhaustion. For example, a covenant can only apply to past conduct so any future sales would not trigger exhaustion. A covenant could also include only the acts of making and using and not “selling” in which case any sales made by the covenantee would not be authorized. So I don’t think the Transcore case can be taken to mean that any covenant must be interpreted as an authorization to sell for exhaustion purposes. You have to see what is the practical effect of the covenant. As per Quanta, if the covenant can be interpreted to authorize sales by the covenantee, then under Transcore it can trigger exhaustion. So to determine the applicability of exhaustion, it comes down really to the scope of the covenant in any given case.

  6. As to the difference between a “covenant not to sue” and a non-exclusive license, some commentators have noted that covenants not to sue were used as a matter of custom or convenience, rather than as a legal principle, to avoid any misunderstanding that the rights conveyed to the recipient were personal in nature and could not be transferred to any other entity. See Annotated Patent Digest § 35:32.50 Covenants Not to Sue. As one court explained it:

    “There is some reason to suppose that the word ‘license’ has become so uncertain of meaning and so encumbered by inconsistent case law respecting the implied rights and obligations of the parties that the draftsman cannot be altogether certain what he has done when he grants a ‘license.’ As a result of this uncertainty, some draftsmen have revised their licensing practices. It is felt that the use of covenants not to sue for infringement may avoid some of the problems of implied assumptions under licenses.”

    Shell Oil Co. v. Schering AG, No. 95-808-SLR., 1997 WL 86414, *3 (D. Del. Feb. 13, 1997) (quoting 1 Harold Einhorn, Patent Licensing Transactions § 1.04[1]-[2].). See also Hilgraeve Corp. v. Symantec Corp., 265 F.3d 1336, 1346, 60 USPQ2d 1291, 1298 (Fed. Cir. 2001) (“Symantec also contends that the covenant not to sue for patent infringement in paragraph 2.2 is equivalent to a freely transferable license to the patent. This court has stated that ‘licenses are considered as nothing more than a promise by the licensor not to sue the licensee.’ The covenant not to sue in paragraph 2.2 does not grant a transferable license to the patent.”).

    But since nonexclusive licenses are ordinarily personal to the holder and nontransferable, the distinction between a covenant not to sue and a license seems illusory. See Troy Iron & Nail Factory v. Corning, 55 U.S. (14 How.) 193, 216,(1852) (“A mere license to a party, without having his assigns or equivalent words to them, showing that it was meant to be assignable, is only the grant of a personal power to the licensees, and is not transferable by him to another.”). See also Annotated Patent Digest § 35:36 Assign ability of License Agreements.

    Transcore does not alter the law that a covenant not to sue does not create an implied license to a downstream user. But effectively, by holding that an unconditional covenant not to sue operates as an authorization for the recipient to make, use, or sell which creates an exhaustion, the holding of the case does mean that the covenant not to sue frees the recipient’s product from any infringement claims for downstream use, and thereby achieves the same result as if the product had been fully licensed or that an implied license had been granted to the downstream user. Cf. Static Control Components, Inc. v. Lexmark Intern., Inc., Nos. 5:02-571, 5:04-84, 2009 WL 891811, *6-*12 (E.D. Ky. Mar. 31, 2009) (on rehearing in view of the intervening Quanta opinion, ruling that Quanta overruled Mallinkrodt and that any authorized sale of a product exhausts the patent rights in that product for all post-sale uses of the product, thus patent law can’t be used to enforce an alleged contractual post-sale use restriction).

    Another interesting case involving covenants not to sue that illustrates the danger from lawyers misunderstanding what the covenants convey, and which case seems to have gone under the radar, is Therasense, Inc. v. Becton, Dickinson and Co., 2008 WL 2323856, *5-*6 (N.D. Cal. May 22, 2008). In that case, the district court, by treating a covenant not to sue as if it were a nonexclusive license, held that when the patentee gave a covenant not to sue to a third party to settle a suit, and did so at the time when the patentee had previously given its manufacturing subsidiary an alleged exclusive license to the patent, and had not joined the exclusive license in the settlement, the patentee had shown that the subsidiary did NOT hold an exclusive license. The court based its holding on the legal principle that an exclusive license is a promise that the patentee will not grant any further licenses to the patent. Textile Productions, Inc. v. Mead Corp., 134 F.3d 1481, 1484 (Fed. Cir. 1998) (“To qualify as an exclusive license, an agreement must clearly manifest the patentee’s promise to refrain from granting to anyone else a license in the area of exclusivity.”); Annotated Patent Digest § 9:54 Patentee Must be Prohibited from Granting any Further Licenses. Hence, in Therasense, by granting a covenant not to sue, the patentee effectively granted the third party a nonexclusive license after the patentee had allegedly granted its manufacturing subsidiary an exclusive license. As a result, the court found that the manufacturing subsidiary did not hold an exclusive license and granted a motion in limine to bar all evidence of alleged lost profits suffered by the manufacturing subsidiary.

    In light of Transcore and Therasense, practitioners should use covenants not to sue with caution. Prudence may dictate that they treat covenants not to sue as just being another name for a nonexclusive license without the royalty obligations.

  7. As a minor correction, the case involved Mark IV radio-frequency identification equipment — not software. Note that the equipment was purchased directly by the customer — the Illinois Tollway. However TransCore chose to sue the systems integrator, ETC Corporation. ETC Corporation was awarded the Illinois Tollway project (worth millions over a several-year period) through a standard procurement process. TransCore submitted a proposal during the procurement process, but lost the project to ETC Corporation’s winning proposal.

  8. Dear Alan McDonald,

    I granted a covenant not to sue to Company X five years ago (the subject patents have not yet expired). The contract expressly specified that the forbearance did not convey to any maker of a system that used the Subject Products. The forbearance did convey to Company X and its customers and others that dealt directly with X. Company X did not sell a system that used the Subject Products.

    The contract also said:
    Nothing in this Agreement shall be interpreted as an admission by X that Subject Products infringe the Subject Patent Rights; or that the Subject Patent Rights are valid and/or enforceable.

    In addition, the contract said:
    Company X agrees to mark the following U.S. and European patent numbers on labeling to be applied to any packaging, CD, disc or envelope for the Subject Products as appropriate.

    Does “TransCore v. Electronic Transaction Consultants” have any bearing on my contract with Company X?, or any maker of a system that uses the Subject Products?

  9. JAOI – You are wrong. That’s exactly what this case holds.

    My reasoning for marking not being triggered by a covenant not to sue. Patent owner offers covenant to avoid or settle suit and includes marking requirement. Defendant says I’ll agree to everything else, but I don’t infringe, no way will I mark. Would patent owner really not settle on the marking issue alone?

  10. A forbearance is not a license.

    Company A grants a patent license agreement to company X.
    That license conveys to X’s customers.

    Company A grants a Covenant Not To Sue agreement to company X.
    That forbearance does not convey to X’s customers (unless the Covenant expressly says so).

    I could be wrong now … but I don’t think so.

  11. Question:
    Can entering a Covenant Not To Sue change “Small Entity Status”?, as does a license agreement.

  12. Am a Non US patent attorney and I must say I agree with Leopold that I too cannot find any real difference between a Covenant and a License plain.
    Would you US Attorneys’ please help me in understanding the same for US or at least give your thoughts on the issue in general?

    Thanks & Regards

  13. Just wondering….

    What if Transcore included a clause in the settlement agreement restricting Mark IV’s downstream sales, for example, prohibiting Mark IV from selling to non-Transcore-authorized companies (such as ETC). What result? Under Quanta, breach of contract only? Wouldn’t the sale to ETC fall outside the scope of the settlement agreement and thus be unauthorized? In such case, wouldn’t ETC be liable for patent infringement?

  14. Re: “Pretty good humor I must say.”

    Yup; number six is right up there with Malcolm. Birds of a feather fluck together.

  15. I’ve been telling clients for years that I wasn’t aware of any meaningful difference between a covenant not to sue (w/ respect to a patent) and a license to that patent. It appears that the Federal Circuit can’t find a difference either.

    Metoo’s concerns are related to other terms of the agreement, not whether the right magic words “license” or “covenant not to sue” are used. I also tell my clients who are accused infringers that it’s not necessary (and often completely inappropriate) to admit infringement to get a license (or a covenant not to sue), or to agree to a royalty base defined in terms of infringement. It seems to me that accepting the marking obligation that metoo suggests would be tantamount to admitting infringement. Sometimes that might be OK, but often it would not.

  16. “I think patents should work out more and do some endurance training so that they’re not exhausted so easily.”

    6,

    Pretty good humor I must say.

  17. I think patents should work out more and do some endurance training so that they’re not exhausted so easily.

  18. This decision makes no sense to me. Clearly it is limited to its facts since Mark IV was a direct infringer and received compensation. What about those who get covenants not to sue in settlement of litigation who are not direct infringers? Every supplier should just start DJ’ing and reach out for covenants. I guess adding conditions to the covenant saves the day, no?

  19. Hopefully my clarification makes sense. I was not suggesting that the recipient of a covenant not to sue has an obligation to mark. Rather, I was suggesting that the patent owner may want to insist on marking as a condition of granting the covenant not to sue–much the same way as should be done when granting a license to someone.

  20. I think the marking issue could indeed come up in a lawsuit against another entity. If the patent owner has granted someone else a “covenant not to sue,” then the language in this decision says that the patent owner has “authorized” product sales by the recipient of that covenant. Under the marking statute, however, the patentee may be unable to get pre-filing damages if someone sold an unmarked patented product “for or under” the patentee. If a covenant not to sue is an “authorization” under the patent, would that not trigger the marking requirement for products sold pursuant to that “authorization”?

    In other words, the recipient receiving a covenant not to sue has no obligation to mark products unless they agree to do so (e.g., in a settlement agreement with the patentee). However, if the patentee does not require marking in exchange for the covenant, could the patentee run afoul of the marking statute in a later infringement suit against a third party (i.e., another infringer who did not purchase product from the party who received the covenant not to sue)?

  21. metoo,

    I am not sure I understand how you think 35 USC 287 is pulled into this. Exhaustion doctrine here obviates any marking requirements of the licensee or receiver of a covenant not to sue. In neither case is the downstream person responsible for marking.

    Can you clarify?

  22. I don’t see why the marking requirement is triggered.

    The defendant still can take the position that the product was not an infringement in the first place and could properly refuse to mark.

    It’s only when the patent owner tries to sue the third party user of the product that the claim that the product is an infringement arises again.

  23. This case may create some serious problems for patent owners who have settled litigation by granting a “covenant not to sue” rather than a license. The opinion in this case equates a covenant not to sue with an “authorization”–same as a patent license. It seems to me that this would also mean that this would also trigger the marking requirement of 35 USC 287. In most settlement agreements providing a “covenant not to sue” rather than a license, there is no requirement that the accused infringer mark products with the relevant patent number(s).

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