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<img class="alignright wp-image-2431 size-medium" src="https://ipintelligencereport.bakerhostetlerblogs.com/wp-content/uploads/sites/11/2016/01/Patent147631712-300x199.jpg" width="300" height="199" />The Supreme Court on Tuesday, May 30, issued an opinion in <a href="https://www.supremecourt.gov/opinions/16pdf/15-1189_ebfj.pdf">Impression Prods., Inc. v. Lexmark Int’l, Inc., No. 15–1189 (S. Ct. May 30, 2017</a>), [hereafter “Lexmark”], reversing the Federal Circuit on two aspects of the patent exhaustion doctrine and redefining the boundaries of the rights afforded a patentee under the Patent Act. Chief Justice Roberts authored the opinion, from which Justice Ginsburg dissented in part.

Under 35 U.S.C. § 154(a), a patent grants to the patentee “the right to exclude others from making, using, offering for sale, or selling” the patented invention. Infringement of a patent occurs when “whoever without authority makes, uses, offers to sell, or sells” the patented invention in the U.S., or imports the patented invention into the U.S. during the life of the patent. 35 U.S.C. § 271(a). But a patentee’s right to exclude and ability to obtain damages for infringement are not without limit. The doctrine of patent exhaustion holds that when a patentee sells a patented item, that sale removes the item from the reach of the Patent Act. Lexmark, slip op. at 6. The purchaser is then free to use, sell or otherwise dispose of the item as he or she sees fit, without fear of liability for infringement.

Prior to this decision, patent exhaustion did not prohibit a patentee from imposing post-sale restrictions on the use of a patented invention, and it did not apply to foreign sales. Lexmark Int’l, Inc. v. Impression Prods., Inc., 816 F.3d 721, 773-74 (Fed. Cir. 2016) (en banc). A patent owner could lawfully condition the sale of a patented product in the U.S., or sell a patented product abroad, and still be able to control downstream sales and uses of the product through infringement actions. This view of patent exhaustion, endorsed by the Federal Circuit’s en banc opinion in 2016, enabled businesses such as Lexmark Inc. to enforce their patent rights after selling their patented products.

Lexmark manufactures refillable toner cartridges for printers; it sells its cartridges in the U.S. either at a 20 percent reduced price with certain restrictions, or at full price with no post-sale restrictions on the purchaser. A purchaser opting for the reduced price agrees to return the used cartridge to Lexmark, whereas a full-price purchaser can keep, resell or discard the cartridge however he or she wishes. Lexmark also sells its cartridges abroad, free of post-sale restrictions.

This business model gave rise to competitors such as Impression Products and other companies that purchase used Lexmark cartridges, refill them with toner and resell them to consumers. Impression also purchases Lexmark cartridges sold to retailers abroad, and imports them into the U.S. When Lexmark sued to stop these “remanufacturers” from reselling refilled cartridges and importing foreign-sold cartridges, the Federal Circuit held that exhaustion did not preclude the remanufacturers’ liability for patent infringement. 816 F.3d at 734.

The Federal Circuit reasoned that patent rights are not exhausted by lawful post-sale restrictions and foreign sales because exhaustion “derives from the prohibition on making, using, selling, or importing items ‘without authority.’” Id. Lexmark could still sue downstream users and sellers of their cartridges who did not abide by the agreement imposed at the time of sale, or who imported the foreign-sold cartridges into the U.S., because these sellers acted “without authority” and therefore infringed. Id. at 734-41.

According to the Supreme Court, the Federal Circuit “got off on the wrong foot” when it began its assessment of exhaustion through the lens of the infringement statute. Lexmark, slip op. at 9. That is because “patent rights yield to the common law principle against restraints on alienation.” Id. at 6. Indeed, “[t]he right to use, sell, or import an item exists independently of the Patent Act,” and should not be viewed first through the lens of infringement. Id. at 9-10.

One question that arises from this analysis is whether patentees may enforce post-sale restrictions on licensees and on consumers who purchase patented items through licensees. Addressing this question, the Court distinguished the rights of a licensee from those of a purchaser. The Court held that patentees remain free to impose restrictions on licensees because a license does not pass title to a product; it merely adjusts “the contours of the patentee’s monopoly” by “expanding the club of authorized producers and sellers.” Id. at 11.

Thus, the Court delicately maneuvered around its own precedent in General Talking Pictures Corp. v. Western Elec. Co. by reasoning that a license carrying restrictions on the licensee does not exhaust patent rights, even though the licensee’s subsequent sales to purchasers in accordance with the restrictions does. 305 U.S. 124 (1938). And where the licensee’s subsequent sales to purchasers violate the license terms, the patentee’s rights are not exhausted because “the patentee has not given authority” for that sale. Lexmark, slip. op. at 12-13.

Also at issue was whether Lexmark’s foreign sales exhaust its patent rights, precluding Impression Products from infringement liability for its importation of foreign-sold Lexmark cartridges. The Federal Circuit’s 2016 opinion reiterated prior holdings that foreign sales do not exhaust a patentee’s right to sue for infringement after the first sale. The Federal Circuit held that the Supreme Court’s intervening decision in Kirtsaeng v. John Wiley &amp; Sons, Inc., which held copyright law’s first sale doctrine is applicable to foreign sales, did not alter patent law’s exhaustion doctrine. 568 U.S. 519, 538 (2013).

The Federal Circuit based its opinion on the differences between copyright law and patent law, and particularly on the territoriality of patent law. Because patentees possess no rights to assert their patents outside of the U.S., the court reasoned, foreign sales should not exhaust their rights in the U.S. 816 F.3d at 752-53.

Over Justice Ginsburg’s dissent on this issue, the Supreme Court rejected the Federal Circuit’s analysis, holding that “[a]n authorized sale outside the United States, just as one within the United States, exhausts all rights under the Patent Act.” Lexmark, slip op. at 13. It clarified that a U.S. retailer that purchases infringing items from a foreign manufacturer still may face liability for infringement even though it bought the items abroad, but only if “the patentee had nothing to do with” the transaction with the foreign manufacturer. Id. at 16. Under Lexmark, a patentee who decides to sell his or her products to a foreign retailer cannot subsequently hold liable for infringement a domestic business that imports the foreign-sold products. Id.

The Court also rejected the “middle-ground” argument, advocated by the government as an amicus, that a foreign sale expressly reserving certain rights to the patentee should not exhaust the patentee’s rights. Id. at 16-18. The government’s position was that foreign buyers would not presume to acquire all the rights pursuant to title in an item, the purchase of which was conditioned on certain post-sale restraints. Id. at 17.

Explaining that this argument “wrongly focuses on the likely expectation of the patentee and purchaser during a sale,” the Court held that exhaustion applies to every authorized sale of a patented item, regardless of restrictions imposed on the buyer and regardless of the buyer’s location. Id. at 18.

Although the opinion sets forth a bright-line rule that is “uniform and automatic” for patent exhaustion, the Lexmark decision severely limits patentees’ ability to control downstream sales and uses of patented products under the force of the patent laws. Id. at 13. Patent owners such as Lexmark that wish to maintain a degree of exclusivity over the downstream commercial activity of their patented inventions will need to devise alternative business models in light of this decision. Such models may incorporate pursuing and asserting method patents, where appropriate, and relying more heavily on remedies under contract law.

If protecting a method of using (and reusing) an invention is not an option for some patent holders facing problems of remanufacturers or other downstream resellers, then perhaps marketing technology in a manner that retains ownership and control of the product is an option. As an example, licensing technology and leasing patented items to users may suggest a way for patent owners to retain protection of their intellectual property.

Such arrangements could better prepare the patentee to pursue remedies for breach of contract while at the same time leaving patent infringement on the table, even after the patentee has placed his or her technology into the market.

Supreme Court Announces ‘Uniform and Automatic’ Rule for Patent Exhaustion