Argument preview: Justices to consider limits on “exhaustion” of patent rights
on Mar 14, 2017 at 10:33 am
The March argument session brings the most important patent cases of this term. In the October (Samsung Electronics Co. v. Apple) and December (Life Technologies Corp. v Promega Corp.) sessions, the justices heard cases that involved rules for multi-component products. The March session features two cases of much more central importance to the patent process. The second week of the session, in TC Heartland v Kraft Foods Group Brands, the justices finally will consider a crucial procedural problem, the rules for patent venue that have been so controversial for the last decade. The first week, they will review Impression Products, Inc. v Lexmark Int’l, Inc., which also presents a momentous transactional question: When a firm holding a patent sells a product to which the patent applies, does the sale necessarily “exhaust” its rights to enforce the patent as to that product? The 34 “friend of the court” briefs filed in the case should give you a sense of the far-reaching ramifications the case might have for innovation policy.
Practical intuition suggests that the sale of the patent product obviously must exhaust the rights of the patentholder: Why would I buy a patented medical tool if I weren’t getting the right to use it? If that intuition has any force, it would bode well for Impression Products, the alleged infringer. And if you’re a regular reader of this blog, your recollection of the court’s firm application of the exhaustion doctrine to protect overseas buyers of copyrighted books in 2013, in Kirtsaeng v. John Wiley & Sons, Inc., might suggest that the present group of justices has a strong inclination to protect purchasers; any such inclination would provide further support for the alleged infringer. Then again, the court’s other 2013 decision on exhaustion – the plant-patent ruling in Bowman v. Monsanto Co. – came down firmly in favor of the patentholder, so perhaps you shouldn’t read all that much into Kirtsaeng.
It is fortunate that the case before the justices involves Lexmark, because Lexmark’s pricing strategy is so simple and well-known that it is easy to understand. Lexmark is one of the leading manufacturers of printers suitable for personal use. It sells its printers at a relatively low price, but charges a relatively high price for the ink cartridges necessary for the printers to operate. Both the printers and the cartridges include technology protected by an assortment of patents; it is accordingly plain that it would violate the Patent Act for competitors to make or sell cartridges without authorization from Lexmark.
This case arises from one of Lexmark’s two pricing schemes for cartridges. The baseline (full-price) scheme sells unlimited-use commercial-grade cartridges; the second scheme (Lexmark’s “Return Program”) sells cartridges at a discount of about 20%. A microchip in those cartridges disables them after their first use; purchasers agree when they buy the cartridges that they will not reuse them or refill them except by returning them to Lexmark. Impression Products operates a business that recycles used Lexmark cartridges in violation of those restrictions. The question before the court is whether Lexmark’s patents follow the cartridges through their sale, use and resale into the hands of Impression Products. All sides agree that the patent law includes some doctrine of exhaustion; the Supreme Court’s earliest cases applying the doctrine predate the Civil War. The court’s old cases, though, do not squarely resolve the two issues presented here: the extent to which a seller can limit exhaustion by conditions in its contract of sale, and the extent to which the doctrine applies to sales of patent-protected merchandise outside the United States.
The case draws its potential importance from two overlapping features of the controversy. First, unlike the Copyright Act at issue in Kirtsaeng, the Patent Act does not include an express provision addressing the extent of exhaustion. This means that the justices are working an area of largely common-law adjudication. Indeed, although most would agree that the exhaustion doctrine should be regarded as an explication of the Patent Act rather than wholly untethered federal common law, the statute itself offers little or nothing to guide (or constrain) the justices in defining the bounds of patent exhaustion. Second, the case comes to the court against the backdrop of more than a decade of Supreme Court decisions developing the idea that the U.S. Court of Appeals for the Federal Circuit (the specialized lower court that hears patent-related appeals) systematically has overprotected patentholders. Justices who view this case through that lens may have little sympathy for the patentholder.
To the extent it turns on any specific authority, the first question in the case – the ability of Lexmark to restrict the use of its patented cartridges after it has sold them – turns on how the court wishes to read its earliest descriptions of the exhaustion doctrine, which generally suggest that a patentholder loses its rights whenever it sells an object “without any conditions” and that a user infringes a patent whenever it acts without the patentholder’s “authority.” The Federal Circuit has taken the view for many years that sale limitations like those that Lexmark imposes should be enforceable because they are the kinds of “conditions” that vitiate any grant of “authority” under those cases. Competitors (like Impression Products in this case) argue that the court was talking about a “conditional sale,” an arcane type of financing transaction, not even enforceable under modern commercial law, in which a seller purports to retain “title” until the buyer finishes paying for its purchase. For that side of the case, then, any sale of the patent-protected product under the authority of the patentholder is an “absolute” sale, without “conditions.” Nobody seriously doubts that Lexmark authorized a sale of the cartridges; for Impression Products, that should be the end of the matter.
To my mind, the justices easily could adopt either reading of the loose language from the old cases. The truth, as the justices certainly will know, is that none of those cases confronted the highly-structured licensing and contracting arrangements that characterize modern commerce. So I’d be surprised if the justices approach this case as an exercise in identifying the best reading of their 19th-century patent jurisprudence. Rather, I expect, they’ll be worrying about the consequences of their decision for innovation policy.
As you would expect, many trees have fallen to produce the voluminous briefing addressing the policy implications of the problem, which is of course a challenging problem of industrial economics. Impression Products, and its many amici, including the solicitor general, emphasize the importance of competitive resale and used-goods markets; allowing a patentholder to limit resale of used products leaves those markets largely at the mercy of the manufacturer. There also is a strong argument that I would characterize (perhaps inaptly) as “intuitive,” suggesting that a patentholder has received its due reward when it has extracted the price that it can get for selling its invention; efforts to reach beyond that sale to constrain post-sale behavior have an unsavory aroma of overreaching.
For its part, Lexmark confines itself almost entirely to a careful and detailed reconstruction of the court’s precedents. The policy reasons why the justices should want to validate Lexmark’s business strategy come from the host of amici that file on its behalf. To distill a great deal of fervid discourse into a few brief sentences, those filings emphasize the complexity of the modern contracting markets that have grown up in the years since the Federal Circuit held these kinds of restrictions enforceable. A particularly compelling brief from Qualcomm makes two key points that play directly to the insecurities that have dominated the court’s analysis in so many of the major patent cases of the Roberts court. First, the brief urges that a sudden shift in the enforceability of these kinds of contracts could destabilize important supply chains that have developed without incident under the existing Federal Circuit rule; that argument should speak loudly to those justices who have been concerned about making a misstep in patent law that would disrupt innovation, and who have been responsible for the court’s frustratingly Delphic pronouncements in cases like Bilski v. Kappos and Alice Corp. Pty. Ltd. v. CLS Bank Int’l.
A second point is that the existing rule, although it might not facilitate competition among resellers, does facilitate competition among business models: Lexmark sells low-cost printers with expensive cartridges (a “razor-blade” model); Epson, by contrast, sells relatively expensive printers with easily refillable ink tanks. The Lexmark model – with its low up-front costs – might be ideal for customers who print relatively little, the Epson model superior for those who print a great deal. How can the justices be sure that the patent law should require patentholders to follow the Epson model? Again, justices self-aware of their lack of comparative expertise in industrial economics may worry about a decision that privileges one arrangement over the other.
I recognize that the extended discussion above includes not a word about the second question before the court – the extent to which overseas sales exhaust domestic patent rights. That is not because I think the question unimportant. Indeed, it well might be even more important than the first question. It reflects, rather, my sense that the Federal Circuit’s analysis of the second question is much harder to unseat. For one thing, if we accept the idea that patent rights are a creature of the Patent Act, then it is hard to see how a sale overseas exhausts rights under the Patent Act. Because each nation has its own patent laws, a United States patent imposes no constraints at all on activities wholly outside the United States. (Hence last month’s decision in Life Technologies Corp. v Promega Corp., discussed here, considering when a manufacturer has purchased enough components from the United States to make its overseas assembly an infringement of the United States patent laws.) If that is so, it is not immediately obvious how an overseas sale could have anything at all to do with rights under the Patent Act, much less compel their exhaustion.
Impression Products is well aware of that problem, which it solves by characterizing exhaustion as a wholly common-law development founded on the common law’s abhorrence of restraints on alienation. The argument is a strong one, and given the vagueness of the court’s prior explanations of the source of the exhaustion doctrine, it could get some traction with some of the justices. My hunch, though, is that the justices will be reluctant to take that route. For one thing, I expect that several of them will have a visceral distaste for describing this long-standing doctrine as a matter of purely judicial artifice, wholly untethered in any statutory scheme. Given the opportunity to anchor the doctrine in the Patent Act, presumably most of them will prefer to do so.
A second problem is that the justices have a brief on this point from the solicitor general, who advises the court that the United States has entered into at least two free-trade agreements (with Australia and Morocco) that contemplate overseas sales that would not exhaust domestic patent rights; it would take something pretty compelling to convince the justices to adopt a rule of federal common law inconsistent with existing treaty obligations.
A final point stems from the apparent practical difficulties of adopting an exhaustion regime for overseas sales. If the Qualcomm brief does a good job of portraying disruption in domestic markets from a mandatory exhaustion regime, the amicus brief that IBM files (limited to the cross-border question) provides a devastating discussion of the disruption that would flow from a rule of mandatory (or even presumptive) exhaustion from overseas sales. Among other things, it points out the relatively feeble patent regimes under which many overseas sales occur; a rule that allowed goods sold in weak-patent regimes to be transported and resold in strong-patent regimes (like the United States) would effectively import the weak-patent regime into United States markets. Moreover, as IBM explains, even the presumptive rule that the solicitor general favors – a presumption that foreign sales exhaust patent rights unless exhaustion is disclaimed in the sales contract – would disrupt existing supply chains because it would protect domestic patentholders only if they could force foreign contract partners to renegotiate their existing contracts to prevent exhaustion. Any justices worried about trying to fix something that isn’t broken will, I think, be most reluctant to overturn the settled transactional framework on that point.
Although this is probably the longest post I have ever written, I have only scratched the surface of the issues that the justices will confront when they take up this case next week. We should learn a lot about their inclinations from the argument.