TECHNOLOGY LAW CORNER
Patent Exhaustion: Supreme Court Fatigue?

The case involves LG licensing some chipset patents to Intel (Nasdaq: INTC) with some express contractual provisions -- including one requiring that Intel notify its customers that the chipsets Intel sells them should not be used with non-Intel products.

In other words, LG and Intel had an agreement -- two actually -- and Intel's customers, including Quanta, were warned against unauthorized usages of the Intel products. The patents in question govern systems and methods employing those and other chipsets and components, whether made by LG, Intel or anyone.

Although Intel gave Quanta the requisite notice and warning, Quanta nonetheless assembled computers using a variety of parts.

Patent Rights Life Span

The doctrine of patent exhaustion is an old and reasonable rule that prevents a patentee from taking multiple bites of the patent apple. Also known as "the first sale doctrine," this rule states that an unconditional sale of an article exhausts the rights of the patentee to further control of that article.

In short, once the item or chipset is sold unconditionally, i.e., a normal sale situation, the patentee has received full value from the patent covering that article or device, and cannot seek further royalties. This is a common sense approach that is well understood by all.

Conditional sales may involve contractual restrictions -- such as Intel's, which was negotiated.

Although winning at the trial level, Quanta lost on appeal, where the Federal Circuit held that LG's patent rights were not exhausted in view of the conditional sale involved. Thus, since the parties had contractual obligations concerning the use of the chipsets, there was no unconditional sale and no patent exhaustion.

Quanta then filed an appeal to the U.S. Supreme Court, which has been quite critical of the Federal Circuit over the last few years -- a point not lost by Quanta's counsel and others in the briefs filed.

Items vs. Systems

Numerous outside organizations have chimed in on the issues. Companies that have patents would like to be sure that their rights to use those patents are not further clipped by the Supreme Court.

Companies that are downstream assemblers -- e.g., Dell (Nasdaq: DELL) , HP (NYSE: HPQ) and others -- argue for the elimination of conditional licenses. That would completely assure that downstream manufacturers -- such as Quanta, intermediaries and customers -- would not be subject to any patent royalties. In other words, the initial purchaser (first sale) would assume the full burden and financial responsibility of the patented item.

Others, such as IBM (NYSE: IBM) , want doctrinal clarity, but they also allow for sophisticated parties to structure the deal in whatever fashion they desire, e.g., royalty-splitting among multiple downstream companies to distribute the burden of the patent royalties among the various involved parties.

Although this case involves chipsets and computers, the biotechnology industry was forced to participate. The issue of patent exhaustion also concerns seeds and DNA, which are inherently self-replicating, thereby complicating the issue of a first sale. The Justices are likely to avoid implicating such innovations in their ruling.

Lost in the melee here are various critical facts that undermine Quanta's case, which will hopefully be noted by the Justices at the oral argument and in the decision expected in a few months.

The traditional doctrine of patent exhaustion concerns the sale of an item or physical thing, which, once the transaction is completed, is transferred or handed over. Thus, any patent covering that unconditionally sold item cannot be used to extract further royalties.

The LG patents in question, however, do not involve items or components, such as the chipsets in the case. Instead, they govern systems that contain such components as chipsets.

Accordingly, the sale and licensing of the chipsets (the items) does not implicate the system (and methods) of LG's patents. There is also Intel's express warning, which Quanta chose to ignore.

Wrong Case for the Job

Although some clarity would be helpful in the doctrine of patent exhaustion, this case is a poor vehicle for change.

Even though the Court has not addressed this issue since 1942, the patent bar hopes that the Supreme Court does not overrule the reasonable approach taken by the Federal Circuit.

Unfortunately, many fear that the Justices may continue their reversals and overrule the lower court, thereby continuing to call into question the value of intellectual property in today's economy.