In Lexmark v. Impression, the Federal Circuit is holding an en banc hearing to consider the impact of both Kirtsaeng and Quanta on issues of patent exhaustion. I wanted to provide the following some discussion of the facts at issue in the case. The following synopsis comes from the patentee Lexmark’s opening brief on the merits:
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The facts relevant to this appeal are not in dispute, and were largely stipulated below. Lexmark is a leading developer and manufacturer of innovative imaging and information management products and services — including laser printers and toner cartridges. Through extensive in-house research and development, Lexmark develops most of the technology that goes into its products and services. These complex innovations are protected by numerous patents. Those at issue in this suit cover various aspects of Lexmark’s toner cartridges — for example, the “encoder wheel” which determines how much toner remains in the cartridge and optimizes the print settings accordingly.
. . . Although Lexmark is known for its printers, much of its profits derive from the sale of toner cartridges to replace the cartridges that come with Lexmark printers. Lexmark offers end-user customers a choice when they purchase these replacement cartridges: a “Regular Cartridge” sold at full price without any use limitations, or a “Return Program” cartridge sold at a discount in exchange for the purchaser’s agreement to use the cartridge only once.
The two types of cartridges are physically identical. (Id.) But under the Return Program, customers agree that after the cartridge’s toner is exhausted, they will return the empty cartridge only to Lexmark for remanufacturing or recycling. Customers who buy regular cartridges, on the other hand, pay full price, but are not subject to the single-use restriction. They may dispose of or refill the cartridge as they see fit.
The Return Program cartridges cost roughly 20 percent less than the unrestricted version. That discount reflects the limitation on customers’ use of the cartridges.
Lexmark sells Return Program cartridges directly (to end-user customers) and indirectly (through “authorized resellers”). The Return Program contractually binds both Lexmark’s authorized resellers and its customers. No Lexmark reseller is authorized to sell a Return Program cartridge that is not subject to the single-use restriction. And whether a customer buys a Return Program cartridge directly from Lexmark or indirectly from an authorized Lexmark reseller, it does so subject to a user agreement that obliges the customer to use the cartridge only once. Given Lexmark’s agreements with resellers as well as end-users, the Return Program is a restriction on both sale and use.
The use restriction — a combination patent license and contract — is clearly displayed, in multiple languages, on the outside packaging of a Return Program cartridge. It also appears on Lexmark’s website. Before opening the product, therefore, customers are advised that they have a choice whether to participate:
RETURN EMPTY CARTRIDGE TO LEXMARK FOR RECYCLINGPlease read before opening. Opening this package or using the patented cartridge inside confirms your acceptance of the following license agreement. The patented Return Program cartridge is sold at a special price subject to a restriction that it may be used only once. Following this initial use, you agree to return the empty cartridge only to Lexmark for recycling. If you don’t accept these terms, return the unopened package to your point of purchase. A regular price cartridge without these terms is available.
This user agreement is an enforceable contract. Both the Ninth Circuit and the U.S. District Court for the Eastern District of Kentucky have rejected *9 challenges to the Return Program. The Ninth Circuit held that Lexmark’s user agreement provides customers with pre-sale notice, an opportunity to opt out, and consideration in the form of the price discount. The Ninth Circuit also found that Lexmark’s label was not misleading. And the Kentucky district court in Static Control Components, Inc. v. Lexmark International, Inc., rejected the argument that Lexmark and its customers lacked a “meeting of the minds,” holding instead that the Return Program “clearly set[s] forth contractual terms” of the type that have been “held to be valid.” Neither Impression nor any other defendant in this litigation challenged the enforceability of the Return Program on contract-law grounds. Indeed, Impression acknowledges that “Lexmark has an express and enforceable” contractual agreement with each of its end-user customers and with its authorized resellers. All remain free, of course, to opt for a Regular Cartridge at regular price.
The Return Program serves a number of important functions.
First, it protects the quality and reputation of Lexmark’s products. Many spent cartridges end up in the hands of “remanufacturers” that refill the toner and repackage the cartridge for sale. (See infraat 12–13.) Used cartridges refilled by third parties are susceptible to malfunctions and poor performance. Because the malfunctions can appear to involve the printer rather than the remanufactured cartridge, customers often blameLexmark rather than the supplier of the inferior knock-off cartridge — leading to warranty claims and fewer future purchases from Lexmark.
Second, the Return Program facilitates Lexmark’s own recycling and remanufacturing programs. In the 1990s, Lexmark began reconditioning its own spent cartridges. The Return Program provides a reliable stream of cartridges for Lexmark’s own remanufacturing efforts, which allow Lexmark to control the quality of its remanufactured cartridges. It also helps the environment by ensuring that *11 cartridges are properly recycled if they are not reused.
Third, the Return Program is part of Lexmark’s defense against piracy and grey-market suppliers. Lexmark’s cartridges are “regionalized” such that a cartridge sold in Europe, for instance, will not work in a printer sold in North America or Latin America. Recovering the cartridges after a single use reduces the opportunity for third-party grey-market activities. Regionalization makes it harder for third parties to use a product sold at a lower price in one market to undercut sales in another, higher-priced market. And even within a region, single-use licensing limits the chances for unauthorized reuse. Rather than restricting post-sale use across the board by imposing single-use requirements on all of its cartridges, however, Lexmark decided to give customers a choice of replacement cartridges by offering both single-use Return Program cartridges and unrestricted regular cartridges. It accounts for the potentially negative consequences of the unrestricted cartridges by pricing them differently than Return Program cartridges.
Each Return Program cartridge contains a computer chip that, among other things, enforces the single-use restriction. The chip monitors the cartridge’s toner level: once all the toner in a Return Program cartridge is consumed, the chip stores this fact in its memory. If the cartridge is later reinstalled, the chip will interact with the printer to disable the cartridge.
Despite this protection, piracy threatens Lexmark’s cartridge sales. Third parties, including foreign companies, have hacked Lexmark’s computer chips and produced new versions that circumvent the single-use license. Those illegitimate chips, once installed in place of Lexmark’s originals, suppress the fact that the cartridge’s original toner was already consumed. This allows a used cartridge sold by a third party to masquerade as a genuine Lexmark cartridge. A Lexmark printer will accept the cartridge despite software designed to disable cartridges reused in violation of their single-use license.
Once the chip is circumvented, Lexmark’s Return Program cartridges may be reused multiple times, in violation of the single-use restriction. “Remanufacturing” a spent toner cartridge for reuse involves replacing worn components and refilling the toner. Companies like Impression and its suppliers gather spent cartridges, install hacked replacement chips, refill the cartridges with non-Lexmark toner, and sell the refilled cartridges for use in Lexmark printers. Although the cartridge may continue to function, the remanufacturing process, if not done correctly, will reduce its print quality over time, causing Lexmark reputational harm. This has happened many times when third parties have refilled and resold used Lexmark cartridges. . . .
In response to widespread piracy, Lexmark took legal action to protect its intellectual property, reputation, and revenues. It first initiated proceedings in the International Trade Commission, where it obtained a general exclusion order and cease-and-desist orders barring the importation of clone, counterfeit, remanufactured, refilled, and empty Lexmark toner cartridges.
Lexmark also sued several parties for patent infringement in this action in the U.S. District Court for the Southern District of Ohio. The suit targeted two types of infringement: the sale of “clone” cartridges manufactured by third parties as unauthorized copies of Lexmark’s genuine toner cartridges; and the sale of other cartridges originally manufactured and sold by Lexmark, such as remanufactured cartridges that had been refilled, repackaged, and resold by third parties under non-Lexmark labels.
During four years of litigation, most defendants agreed to individual settlements with Lexmark, leading the district court to enter consent judgments and stipulated permanent injunctions. In some instances, the court enforced Lexmark’s patent rights through contempt proceedings or default judgments. Impression is the sole remaining defendant litigating against Lexmark. . . .
With respect to Lexmark cartridges first sold outside the United States, Impression maintained that Lexmark’s sales abroad precluded Lexmark from suing for infringement of its U.S. patents when those cartridges were imported, remanufactured, or resold in the United States. Impression acknowledged that its position contradicted this Court’s ruling in Jazz Photo, which held that a foreign sale does not exhaust U.S. patent rights. But Impression contended that Jazz Photo had been implicitly overruled by the Supreme Court’s decision in Kirtsaeng. The district court disagreed, noting that Kirtsaeng construed a distinct provision of the Copyright Act and therefore did not implicitly overrule Jazz Photo’s application of the Patent Act.
As to Lexmark cartridges first sold in this country, Impression argued that Lexmark’s patent rights were exhausted despite the express contractual conditions under the Return Program. Again, Impression recognized that the *16 law of this Court was to the contrary, given Mallinckrodt’s holding that a sale under a single-use license did not exhaust the seller’s patent rights. But the district court accepted Impression’s contention that the Supreme Court’s decision in Quanta — which addressed an unrestricted first sale — implicitly overturned Mallinckrodt’s holding regarding a restricted sale. The district court’s opinion rested on its (mistaken) understanding that Lexmark resellers possess blanket authority to sell Return Program cartridges without restriction on their subsequent use. In this respect, the court held, Lexmark’s domestic sales of cartridges were analogous to Intel’s sales of software without restriction in Quanta — sales that, as decided by the Supreme Court, exhausted patent rights.
Both Lexmark and Impression, however, recognized that the district court had misunderstood the facts concerning Lexmark’s domestic sales, and that Lexmark’s contracts and licenses did in fact restrict the resale of Return Program cartridges. To avoid the need to amend the Complaint and undertake additional briefing, the parties submitted a joint motion asking the court to supplement the record with stipulated facts and then either to reconsider its decision on the Return Program cartridges or enter final judgment to facilitate appeal.
The district court supplemented the record with the stipulated facts, but declined otherwise to revisit its decision. Instead, the court entered a stipulated judgment of non-infringement in favor of Impression with respect to Return Program cartridges first sold inside the United States, and a stipulated judgment of infringement in favor of Lexmark with respect to cartridges first sold outside the United States. The court also entered a stipulated permanent injunction, barring Impression from selling the Accused Products in the United States, except to the extent that Lexmark’s patent rights had been held to have been exhausted.