Quanta exhaustion and its effect on licensing

In Quanta Computer Inc v LG Electronics Inc, the court unanimously ruled that the authorised sale of an article that substantially embodies a patent exhausts the monopoly originally granted to the patent holder, preventing the patent holder from claiming infringement against unauthorised postsale use of the article.

In the case, LG Electronics licensed a patent portfolio to Intel Corporation, authorising Intel to manufacture and sell microprocessors and chipsets that used the LG patents. In a separate agreement (the associated ‘Master Agreement’) with LG, Intel agreed to give notice to its customers that the Intel licence did not extend to “any product that you make by combining an Intel product with any non-Intel product”.

Quanta, which purchased the Intel microprocessors and chipsets, combined those products with non-Intel memory and buses in ways that practised the LG patents. While the Intel products sold to Quanta didn’t fully practise the LG patents on their own, since LG suggested no reasonable use for the Intel products other than incorporating them into computer systems— the combination of which practised the LG patents—the Intel items were seen as substantially embodying the LG patent.

As LG had authorised Intel to sell the products in the licensing agreement, the doctrine of exhaustion applied and LG lost its post-sale enforcement right to claim infringement against Quanta. The Quanta holding applied exhaustion to any authorised first sale of method as well as apparatus inventions, and restricted or even eliminated a patent owner’s control subsequent to an authorised sale.

In Quanta, the court did not prohibit post-sale control in licensing agreements; such controls, however, must not be applied subsequent to an authorised sale of an article substantially embodying the patent. The Quanta court interpreted the LG-Intel licence agreement to have no limitations that would cause the sale of the components to Quanta to be unauthorised.

Specifically, the court stated that the agreement “broadly permits Intel to ‘make, use, or sell’ products free of LGE’s patent claims [emphasis added]”. Thus, while the agreement attempted to control postsale use, it did not clearly make the sale for such use unauthorised. As the doctrine of exhaustion applies only to authorised sales, if a particular sale is unauthorised, eg, not licensed, infringement by the purchaser would occur.

Express field of use limitations on the scope of the licence grant are enforceable as upheld in General Talking Pictures Corp v Western Electric Co in 1938, in which a patent owner had granted a non-exclusive licence to sell a patented product singularly for home use, and thus a commercial use was not authorised.

In Quanta, an express limitation in the licence agreement similar to that in the LG Master Agreement, but clearly excluding the sale of Intel microprocessors and chipsets to those who would combine the products with unsanctioned equipment from the licence grant, would have made the sale to Quanta unauthorised, thus avoiding exhaustion.

The Federal Circuit’s 2011 decision in Tessera, Inc v International Trade Commission (ITC) suggests the eff ectiveness of express limitations in the licence grant to allow post-sale control. Tessera licensed semiconductor technology to more than 60 semiconductor technology companies, with standardised licensing language:

“Subject to the terms and conditions [of this agreement], Tessera hereby grants Licensee a ... license to the Tessera Patents ... and to sell ... and/or offer for sale such TCC (Tessera Compliant Chip) Licensed Products.” Each agreement also stated, “Licensee is licensed only to Licensed Products for which Licensee or a third party has satisfied a royalty obligation of Tessera.”

“thE tESSERa DECIsIon stRonGLY IMPLIEs thAt ExPLICIt LIMItAtIons to thE GRAnt to REnDER unAuthoRIsED CERtAIn sALEs ARE A VIABLE MEAns FoR PAtEnt oWnERs to REtAIn ContRoL oF DoWnstREAM usE.”

The mechanics of the business process dictated that there would be a delay between the licensee’s sales and payment of royalties. On appeal, Tessera argued that the ITC improperly found patent exhaustion without an authorised sale, as some licensees were delinquent with their royalty payments.

Tessera contended that the sales by delinquent licensees were unauthorised, and should not trigger the doctrine of exhaustion.

Federal Circuit was careful to point out that there was nothing in the agreement that explicitly stated that the condition of royalties was directly linked to the authorisation of sale, and therefore found that the initial express authorisation by Tessera was not subsequently transformed into an unauthorised sale based upon the delinquent payment of royalties.

While not used in this licensing agreement, this decision strongly implies that explicit limitations to the grant to render unauthorised certain sales are a viable means for patent owners to retain control of downstream use.

While the Quanta ruling strengthened the doctrine of patent exhaustion, there are still means to retain patent right-based control after the first sale of an article. For exhaustion to occur, the sale must be of a product that substantially embodies the patent; the sale must, also, be authorised.

Therefore, a clear and unequivocal limitation of the licence grant which makes the sale unauthorised under certain conditions would probably be enforceable. Alternatively, if the product sold does not substantially embody the patent, exhaustion does not occur.

Suggesting valid uses of the product being sold which fall outside the patent scope would, therefore, help avoid exhaustion. The objective in Tessera was to ensure that the Tessera licence could be enforced by action for infringement in addition to breach of contract. Ensuring that the royalty is paid before the licence grant occurs should accomplish this objective.

An explicit conditioning of authorised sale upon royalty payment would ensure exhaustion is avoided until after royalties are paid. It appears that once a sale of a product embodying the patent is authorised (ie, it falls within the licence grant), the patent rights are exhausted. So effective downstream control must occur by limiting or conditioning the grant, and not by controlling behaviour postgrant.