Plummeting home prices, joblessness, soaring food and gasoline prices, and shuttered businesses are the backdrop for the recent opinion of the U.S. Supreme Court in Quanta Computer, Inc. v. LG Electronics, Inc.1 If the state of the economy can be an indicium of the Court’s decision, its history augurs the recent outcome.
From 1880 to 1892, as the U.S. economy struggled to transform from its agrarian roots, the Court invalidated many patents for “want of invention.” Over the next 38 years, however, with surging economic conditions, many patents were held valid by the Court. Then from 1930 to 1950, with the onset of the Great Depression and World War II, the Court again adopted its previous bias, which caused one justice to complain that the only valid patents were those the Court had not seen. Given current economic conditions, patents are in trouble again.
LG Electronics, Inc. owns three patents that improve data access between a microprocessor and main memory. LG Electronics granted a license (License Agreement) under the three patents to Intel Corporation to manufacture and sell microprocessors covered by the license. Although broad, the License Agreement excluded a license grant to “any third party for the combination by a third party of License Products … with items, components, or the like acquired … from sources other than [from LG Electronics or Intel].”
Separate from the License Agreement, Intel executed another agreement (Master Agreement) with LG Electronics in which Intel was to notify its customers that the license to purchase Intel products was conditional and “does not extend, expressly or by implication, to any product that you make by combining an Intel product with any non-Intel product.” As customers of Intel, Quanta Computer, Inc. and a group of computer manufacturers (Quanta) received the notice required by the Master Agreement, but Quanta proceeded to combine Intel microprocessors with non-Intel memory and data transmission paths. LG Electronics sued Quanta, asserting patent infringement.
Many commentators focused right away on the Court’s discussion of the patent exhaustion doctrine, which terminates all patent rights of a patentee who has authorized an initial sale of a patented product. It is clear that the patented product, if sold, exhausts patent rights of the one patent that covers the patented product. It is also clear that an unfinished product, which embodies essential features of the patented product, if sold, also exhausts patent rights. The question in this case was whether the unfinished product, if sold, can exhaust patent rights of one or more patents covering both the patented product as well as patented methods of making or using the patented product. The answer is yes, according to the Court.
LG Electronics argued that prior exhaustion cases, including United States v. Univis Lens Co.2, discuss removing portions of the unfinished product, such as grinding an unfinished lens to a prescription, whereas in this case, the unfinished product required the addition of components, such as memory and data transmission paths to the microprocessors. The Court rejected that argument:
But we think that the nature of the final step, rather than whether it consists of adding or deleting material, is the relevant characteristic. In each case, the final step to practice the patent is common and noninventive: grinding a lens to the customer’s prescription, or connecting a microprocessor or chipset to busses or memory.
This comment by the Court is revealing. If the final step is uncommon and inventive, it seems that, under the logic of the Court, exhaustion theory does not apply. This logic cannot easily be reconciled with Univis, which involved a patent issued to eight method claims directed to steps of grinding a lens. Given that the U.S. Patent and Trademark Office issued a patent for lens-grinding steps to Univis, the steps must at least be inventive. If, however, the eight patented method claims are not embodied by the unfinished product, the remaining patents in Univis are all directed to articles of manufacture, and thus lack the basis for the Court’s decision.
The tragic lesson of this case does not lie in the nuanced philosophical arguments of the patent exhaustion doctrine. If the Court is correct, resolution of such arguments lies in contract drafting, since the patent exhaustion doctrine has been stable since 1942 with the decision of Univis. The problem lies with the License Agreement, the Master Agreement and their contractual interplay.
The Court noted that although the Master Agreement imposed a duty on Intel to notify its customers of the conditions for the license, the Master Agreement provided that “breach of this [Master Agreement] shall have no effect on and shall not be grounds for termination of the [License Agreement].” Thus, even if Intel breached the Master Agreement (and no such contention was made), the License Agreement remained intact.
The License Agreement provided two licensing paths. In one, LG Electronics broadly granted Intel all the patented rights to make, use or sell products free of patent claims. In the other, no license was granted to a third party that combined an Intel product with any non-Intel product.
The Court viewed the first path as an initial sale of patented products that exhausts one or more product and/or method patents. Because Quanta purchased exhausted patented products from Intel, LG Electronics’ claims of patent infringement against Quanta failed.
In Quanta, the Court is reining in the power of patents by clarifying the patent exhaustion doctrine. A sale of an unfinished product may exhaust patent rights that may not be part of a patent license if the unfinished product embodies essential features of a patented invention, be it a patented product or a patented method of making or using the patented product.
To avoid such a result, a private agreement, such as a patent license, may be structured to condition the authorized sale of products between the licensor and the licensee. Such a patent license may restrict the licensee’s right to sell patented products to purchasers who intend to combine or use them in a way that is repugnant to the licensor.
Peter Chu is a member of Christensen O’Connor Johnson Kindness PLLC, and can be reached at peter.chu@cojk.com.
1 553 U.S. ___ (June 9, 2008).
2 316 U.S. 241 (1942).
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