Guest post by Samuel F. Ernst, Assistant Professor of Law at the Chapman University Dale E. Fowler School of Law.

Lexmark International, Inc. sells its patented printer cartridges directly to customers and indirectly through authorized resellers.  Ordinarily these authorized “first sales” would exhaust Lexmark’s patent rights in the cartridges, such that Lexmark could not sue third parties, such as Impression Products, Inc., for patent infringement when they refill and resell the spent cartridges at a reduced price.  However, after Lexmark’s authorized and indiscriminate first sale occurs, the end user finds that Lexmark has printed a proposed license agreement on the outside packaging providing that by opening his or her printer cartridge, the customer “agree[s] 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.”  In patent parlance, this provision is known as a “post-sale restriction” – an attempt to restrict the use of a patented item for its intended purpose after the patent holder has authorized a first sale.  The Federal Circuit has granted en banc review in the case of Lexmark v. Impression Products to settle once and for all whether such post-sale restrictions are effective to prevent patent exhaustion, allowing the patent holder to pursue the patented item down the stream of commerce to prevent resale price competition or collect infringement damages above and beyond the monopoly price it earned at the first sale.[1]

One would have thought the question settled by the Supreme Court long ago.  In 1917 the Court decided in Motion Picture Patents Co. v. Universal Film Manufacturing Co. that such post-sale restrictions are ineffective to prevent patent exhaustion.[2]  In that case Motion Picture Patents held a patent on film projectors and granted a license to a third party authorizing the manufacture and sale of the projectors.  The licensee was required to affix a plate to the projectors it sold purporting to impose a post-sale restriction very similar to the restriction Lexmark affixes to its printer cartridge packaging: “The sale and purchase of this machine gives only the right to use it solely with moving pictures containing the invention of reissued patent No. 12,192, leased by a licensee of the Motion Picture Patents Company…. The removal or defacement of this plate terminates the right to use this machine.”[3]  Despite authorizing the sale of its patented projectors and collecting a full monopoly price for its invention, Motion Pictures Patent Company sought to restrict end users from using the projectors with film reels other than those licensed under its separate patent on film reels, just as Lexmark seeks to use the patent law to prevent the reuse and resale of its spent cartridges with unauthorized ink.  When Universal Film supplied end users of the projectors with film reels that were not authorized for use with the machines, Motion Pictures Patent Company sued for infringement.[4]  The Court held that the post-sale restriction was invalid and did not prevent the exhaustion of Motion Picture Patent Company’s rights in the machine.  The Court held that “the right to vend is exhausted by a single, unconditional sale, the article sold being thereby carried outside the monopoly of the patent law and rendered free of every restriction which the vendor may attempt to put upon it.”[5]

The Supreme Court grounded its holding in two policies that are central to the exhaustion doctrine.  First, because the patent law attempts a delicate balance between encouraging innovation and allowing free market competition, the patent holder should not be overcompensated for a license to its intellectual property beyond the free market value of the invention as determined by the free market at the first sale.  “[T]he primary purpose of our patent laws is not the creation of private fortunes for the owners of patents, but is ‘to promote the progress of science and the useful arts.’”[6]  Accordingly, a right to exclude, exercised and exhausted with a single sale or license of a patented product on the open market is the appropriate compensation to reward the value of the invention; nothing more should be given:

This construction gives to the inventor the exclusive use of just what his inventive genius has discovered.  It is all that the statute provides shall be given to him and it is all that he should receive, for it is the fair as well as the statutory measure of his reward for his contribution to the public stock of knowledge.  If his discovery is an important one, his reward under such a construction of the law will be large, as experience has abundantly proved; and if it be unimportant, he should not be permitted by legal devices to impose an unjust charge upon the public in return for the use of it.  For more than a century this plain meaning of the statute was accepted as its technical meaning, and that it afforded ample incentive to exertion by inventive genius is proved by the fact that, under it, the greatest inventions of our time, teeming with inventions, were made.[7]

Hence, the exhaustion doctrine and the invalidity of post-sale restrictions prevent overcompensation, or “double recovery,” for patent holders.

Second, the Motion Picture Patents Court reasoned that the exhaustion doctrine is grounded in the policy against restraints on the alienation of chattels – i.e., servitudes that run with personal property.  Once a patent holder has authorized the sale of its product, downstream purchasers of the item, including competitors in the used resale market, have a reasonable expectation that the product they buy can be used for its intended purpose.  The Supreme Court explained that a ban on post-sale restrictions avoids a situation where a patent holder can:

send its machines forth into the channels of trade of the country subject to conditions as to use or royalty to be paid, to be imposed thereafter at the discretion of such patent owner.  The patent law furnishes no warrant for such a practice, and the cost, inconvenience, and annoyance to the public which the opposite conclusion would occasion forbid it.[8]

The Supreme Court relied on this same policy against restraints on alienation in the recent Kirtsaeng decision, where it decided that the authorized first sale of a copyrighted article overseas exhausts the copyright owner’s right to prevent the used resale of that item.[9]  The Court stated that the exhaustion doctrine is grounded in “the common law’s refusal to permit restraints on the alienation of chattels.”[10]  And the Federal Circuit has recently relied on this policy in support of its decision that giving away a patented product in exchange for no consideration (rather than selling it) can trigger patent exhaustion.  The Circuit reasoned that if patent exhaustion were easily evaded, “consumers’ reasonable expectations regarding their private property would be significantly eroded” and it would “offend against the ordinary and usual freedom of traffic in chattels.”[11]  Nor is the policy against restraints on alienation an outmoded relic of the common law having no justification in the modern economy.  As Professor Molly Shaffer Van Houweling argues in her compelling article, The New Servitudes, personal property servitudes result in notice and information costs for consumers, result in the underuse or inefficient use of resources subject to the restriction (such as the spent printer cartridges at issue here), and waive the limitations built into intellectual property law that are intended to strike the delicate balance between encouraging innovation and allowing for the dissemination of new technology.[12]

In its opening Federal Circuit brief, Lexmark relies heavily on a different Supreme Court case to argue for the validity of its post-sale restriction, the 1938 case General Talking Pictures Corp. v. Western Electronic Co.[13]  But General Talking Pictures does not deal with a post-sale restriction imposed after an authorized first-sale releases a product into the stream of commerce.  Rather, General Talking Pictures recognizes the validity of a pre-sale restriction, whereby a patent holder expressly limits the parties to whom its reseller may sell the patented product in the first place.  In General Talking Pictures, the plaintiff licensed the American Transformer Company to make and sell its patented vacuum tube amplifiers, but stated in the license that American Transformer was only authorized to sell the amplifiers to private consumers “for radio amateur reception, radio experimental reception, and home broadcast.  [American Transformer] had no right to sell the amplifiers for use in theaters as a part of talking picture equipment.”[14]  American Transformer then made an unauthorized sale to the defendant for use in movie houses, even though the defendant “had actual knowledge that [American Transformer] had no license to make such a sale.”[15]  The Court held that the plaintiff could sue for patent infringement because it did not authorize American Transformer to make the sale, and the first requirement of patent exhaustion was therefore not satisfied – there was no authorized first sale: “[t]he Transformer Company could not convey to petitioner what both knew it was not authorized to sell.”[16]  Hence, the Supreme Court drew a distinction between (1) a post-sale restriction, which attempts to impose restrictions on the patented item after an authorized sale; and (2) a pre-sale restriction, which limits the scope of the authority to sell, authorizing sale for only particular uses or to particular customers.  Post-sale restrictions are clearly ineffective to prevent patent exhaustion because the patented item has already passed out of the patent monopoly at the time of sale.  The effectiveness of pre-sale restrictions, and the wisdom of enforcing them, is an interesting and novel question, which I explore in the context of licenses to settle patent litigation in Patent Exhaustion for the Exhausted Defendant: Should Parties be able to Contract Around Exhaustion in Settling Patent Litigation?.[17]  But the adhesion contract Lexmark prints on its cartridge packaging is plainly a post-sale restriction, rendering the General Talking Pictures case inapposite to the Lexmark case.  After Lexmark indiscriminately sells or authorizes the sale of its printer cartridges to all comers, it tries to prevent their resale through the use of a post-sale restriction, but it cannot do so under the patent law because the authorized sale means that the cartridges have already passed out of the patent monopoly.

If the Supreme Court decided this question in the 1917 Motion Picture Patents case, then why is this even an issue for en banc review?  It is because a panel of the Federal Circuit, in Mallinckrodt v. Medipart, held that post-sale restrictions similar to Lexmark’s adhesion contracts can, in fact, prevent patent exhaustion.[18]  In that case Mallinckrodt sold its patented aerosol mist delivery devices to hospitals, stamped with the legend, “Single Use Only,” and a package insert “instruct[ing] that the entire contaminated apparatus be disposed of in accordance with procedures for the disposal of biohazardous waste.”[19]  Many hospitals did not heed the restriction, however.  Instead, they sold the spent devices to the defendant Medipart, who refurbished them and returned them to the hospitals for additional use.[20]  Mallinckrodt sued Medipart for patent infringement and indirect patent infringement, and the Federal Circuit held that the “single use” restriction prevented patent exhaustion.  The court achieved this by cabining the holding of Motion Pictures Patents to circumstances where patent holders attempt to enlarge the scope of their monopoly by tying the use of their patent to the use of unpatented or separately patented items, in violation of antitrust laws or constituting patent misuse.  Hence, the court distinguished Motion Picture Patents and other Supreme Court exhaustion precedent on the basis that “[t]hese cases established that price-fixing and tying restrictions accompanying the sale of patented goods were per se illegal.  These cases did not hold, and it did not follow, that all restrictions accompanying the sale of patented goods were deemed illegal.”[21]  The Federal Circuit then limited the ineffectiveness of post-sale restrictions to circumstances where the patent holder causes anticompetitive effects under the antitrust laws:

Unless the [post-sale restriction] violates some other law or policy (in the patent field, notably the misuse or antitrust law) private parties retain the freedom to contract concerning conditions of sale.  The appropriate criterion is whether Mallinckrodt’s restriction is reasonably within the patent grant, or whether the patentee has ventured beyond the patent grant and into behavior having an anticompetitive effect not justifiable under the rule of reason.[22]

But why should the patent laws be relegated to the shadows of antitrust policy? Intellectual property law is not solely concerned with preventing supra competitive prices or keeping licensing practices within the “rule of reason,” like some shambling poor relation to antitrust law.  Rather, intellectual property laws promote wholly different policies in wholly different ways, such as by balancing the incentive to innovate against the harm of a limited monopoly.  That is why the policies supporting patent exhaustion enunciated by the Supreme Court in Motion Pictures Patent Company were not limited to preventing illegal patent tying (although the Court did mention as one of the supports for its decision a concern with patent holders enlarging the effective scope of their patent claims beyond the claimed invention).  As discussed above, the Court also invoked the policy against servitudes running with personal property and the need to ensure that the exclusionary right is narrowly tailored to achieve the incentive to innovate.  And these policies in support of patent exhaustion have been repeated by the Court in Kirtsaeng and by the Federal Circuit in cases such as LifeScan.  Hence, under Supreme Court precedent, a post-sale restriction is ineffective to prevent patent exhaustion whether or not it has “anti-competitive effects” or the patent holder has “market power.”

If there were any doubt as to this proposition, it should have been settled by the Supreme Court’s 2008 decision in Quanta Computer Inc. v. LG Electronics, Inc.  In Quanta, LG granted Intel the unconditional right to manufacture and sell its patented microprocessors.[23]  But the license also had a provision in which LG “disclaimed” that it granted a license to downstream purchasers of the microprocessors allowing them to combine the devices with non-Intel parts and resell them.[24]  And by separate agreement, Intel was required to notify purchasers of the microprocessors that they were not authorized to combine the microprocessors with non-Intel parts for resale,[25] similar to the notice Lexmark gives its customers that they are not authorized to return the spent printer cartridges to anyone other than Lexmark.  Intel made the patented processors and sold them to Quanta, which then practiced LG’s patent claims by inserting them into computers and reselling them to customers.[26]  And so LG sued Quanta for patent infringement.  The Federal Circuit held that LG had not exhausted its patent rights, because “[a]lthough Intel was free to sell its microprocessors and chipsets, those sales were conditional, and Intel’s customers were expressly prohibited from infringing LG’s combination patents.”[27]

The Supreme Court reversed the Federal Circuit, holding that LG unconditionally authorized the sale of the chips, despite the contract’s language disclaiming a license to third parties and the notice Intel gave purchasers that they could not combine the chips with non-Intel parts.[28]  Although the contract purported to put restrictions on what Intel’s customers could do with the chips once they bought them, these restrictions came only after an authorized sale, and “[n]othing in the License Agreement restricts Intel’s right to sell its microprocessors and chip sets to purchasers who intend to combine them with non-Intel parts.  It broadly permits Intel to ‘make, use, [or] sell’ products free of LGE’s patent claims.”[29]  The Court dispensed with LG’s language disclaiming an implied license by holding that “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 LGE patents.”[30]  In other words, once LG authorized Intel to sell the chips to third parties, the patent rights were exhausted, and LG had no more patent rights to license or refrain from licensing.  Quanta could use the microprocessors without a license.  Similarly, once Lexmark sold directly or authorized the sale of its cartridges to customers, its patent rights in the cartridges were exhausted, and Lexmark retained no patent rights in the cartridges to license or refrain from licensing beyond the single use.  Significantly, the Supreme Court makes no mention of market power, the “rule of reason,” or any other antitrust policy as the basis for its decision in Quanta.  Patent exhaustion is not merely a reiteration of antitrust law.

Some commentators have noted that the Quanta decision is arguably ambiguous with respect to whether it did away with post-sale restrictions altogether or whether it was simply the particular way in which the LG-Intel license was drafted that failed to overcome patent exhaustion.  Perhaps the post-sale restriction was ineffective simply because it was drafted in the language of a disclaimer of implied license, separate from the unconditional grant to Intel of the right to sell the microprocessors.  The lower courts, including the Federal Circuit, have rejected this unlikely reading of the Quanta case.

In TransCore, LP v. Electronic Transaction Consultants Corp., the Federal Circuit addressed the issue indirectly.  In that case, the patent holder had entered into a settlement agreement with a third party, Mark IV, in which it covenanted not to sue Mark IV for infringement when it sold the licensed products.[31]  Subsequent to the settlement, TransCore sued Mark IV’s downstream customers for infringement after they purchased the licensed products.  The holding of the case is that a covenant not to sue for patent infringement is no different from an affirmative license to practice patents; both trigger patent exhaustion.[32]  There was no express provision in the settlement license purporting to contract around patent exhaustion.  However, TransCore sought to rely on extrinsic evidence to the contract showing “the parties’ intent not to provide downstream rights to Mark IV’s customers….”[33]  The Federal Circuit held that the district court’s exclusion of the extrinsic evidence did not affect a substantial right of TransCore because “[t]he only issue relevant to patent exhaustion is whether Mark IV’s sales were authorized, not whether TransCore and Mark IV intended, expressly or impliedly, for the covenant to extend to Mark IV’s customers.”[34]  In other words, once the sales are authorized, an express or implied provision purporting to limit the effect of patent exhaustion (such as the product label at issue in Lexmark) has no effect.

In Tessera, Inc. v. International Trade Commission, the Federal Circuit held that a licensee’s authorized sale of an item resulted in patent exhaustion, shielding purchasers of the patented product from an ITC exclusion order.[35]  Moreover, the authorized sales did not retroactively lose their authorization due to the licensee’s failure to pay the patentee its royalties.[36]  The Federal Circuit rejected this argument because “[t]hat absurd result would cast a cloud of uncertainty over every sale, and every product in the possession of a customer of the licensee, and would be wholly inconsistent with the fundamental purpose of patent exhaustion – to prohibit post sale restrictions on the use of a patented article.”[37]

Finally, the Eastern District of Kentucky explicitly rejected Lexmark’s post-sale restriction as effective to prevent patent exhaustion in Static Control Components, Inc. v. Lexmark International, Inc.[38]  The court noted that there was a debate among academics as to whether the Supreme Court had broadly rejected post-sale restrictions as sufficient to defeat patent exhaustion, or if “the Quanta holding is limited to the very specific facts, and the very specific license agreement, that confronted the Court.”[39]  The court concluded “that Quanta overruled Mallinckrodt sub silentio.  The Supreme Court’s broad statement of the law of patent exhaustion simply cannot be squared with the position that the Quanta holding is limited to its specific facts.”[40]  One might add that even if one did suppose that the Supreme Court granted certiorari in Quanta to opine on the details of the language of a particular license agreement, it had already ruled that post-sale restrictions are ineffective altogether to avoid patent exhaustion in the 1917 Motion Pictures Patent Co. case.

And so Lexmark’s post-sale notices to customers that they must return their spent printer cartridges to Lexmark are ineffective to prevent patent exhaustion.  This does not mean that Lexmark is without a remedy to quell competition from the used resale market – only a remedy under the Patent Act.  For example, Lexmark spills much ink in its opening Federal Circuit brief arguing that the single-use restriction printed on its product packaging is “an enforceable contract” in the Ninth Circuit.  Accordingly, Lexmark could attempt to sue its customers for their alleged breaches of the adhesion contract (despite the customer relations difficulties this might cause).  As a further example, Lexmark complains in its brief that the used cartridges refilled by third parties are susceptible to malfunctions and poor performance, and that customers often blame Lexmark rather than the supplier of the used cartridge.  If customers are indeed susceptible to such source confusion, then the remedy would appear to sound in trademark law, not patent law.  Finally, Lexmark could pursue non-legal strategies, such as making its prices more competitive with the used resale market, or competing based on quality, which it apparently already does, given the supposed malfunctions of the used cartridges.  It would be a fine world if refilling the ink in one’s printer did not cost nearly so much as the printer itself.

Hence, Lexmark has other avenues to pursue to prevent the resale of its used cartridges.  But patent law has its own requirements and its own remedies, separate from the rules and remedies of contract law and trademark law.  This is appropriate, because patent law promotes different policies than those other branches of law.  These include the rules and policies of patent exhaustion, which prohibit a patent holder from pursuing an item down the stream of commerce once the patent rights in that item have been exhausted.

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[1] The Federal Circuit’s en banc order, available here, also asks the parties to brief the separate question of whether the authorized first sale of a patented item overseas gives rise to patent exhaustion, a topic not treated in this post.

[2] 243 U.S. 502 (1917).

[3] Id. at 506-07.

[4] Id. at 508.

[5] Id. at 452.

[6] Id. at 511 (quoting U.S. Const. art. I, § 8).

[7] Id. at 513.

[8] Id. at 518.

[9] Kirtsaeng v. John Wiley Sons, Inc., 133 S. Ct. 1351, 1363 (2013).

[10] Id.

[11] LifeScan Scotland, LTD v. Shasta Techs., 734 F.3d 1361, 1363, 1376 (Fed. Cir. 2013) (internal quotation marks and citation omitted).

[12] Molly Shaffer Van Houweling, The New Servitudes, 96 Geo. L. J. 885, 932-46 (2008).

[13] 304 U.S. 175 (1938).

[14] Id. at 180.

[15] Id.

[16] Id.

[17] 2014 U. Ill. J.L. Tech. & Pol’y 445 (2014).

[18] 976 F.2d 700, 709 (Fed. Cir. 1992).

[19] Id. at 702.

[20] Id.

[21] 976 F.2d 700, 704 (Fed. Cir. 1992).

[22] Id. at 708.

[23] 553 U.S. 617, 636 (2008).

[24] LG Elecs., Inc. v. Bizcom Elecs., Inc., 453 F.3d 1364, 1370 (Fed. Cir. 2006), rev’d sub nom., Quanta, 553 U.S. at 638.

[25] Id.

[26] Quanta, 553 U.S. at 624.

[27] LG Elecs., 453 F.3d at 1370.

[28] Quanta, 553 U.S. at 635-37.

[29] Id. at 636.

[30] Id. at 637.

[31] 563 F.3d 1271, 1276 (Fed. Cir. 2009).

[32] Id. at 1276-77.

[33] Id. at 1277.

[34] Id. (emphasis added).

[35] 646 F.3d 1357, 1370 (Fed. Cir. 2011).

[36] Id.

[37] Id. (emphasis added).

[38] 615 F. Supp. 2d 575, 585 (E.D. Ky. 2009).

[39] Id.

[40] Id. at 585-86.