Quanta Computer, Inc. v. LG Electronics, Inc.

Quanta Computer, Inc. v. LG Electronics, Inc., 553 U.S. 617 (2008), is a case decided by the United States Supreme Court in which the Court reaffirmed the validity of the patent exhaustion doctrine.. The decision made uncertain the continuing precedential value of a line of decisions in the Federal Circuit that had sought to limit Supreme Court exhaustion doctrine decisions to their facts and to require a so-called "rule of reason" analysis of all post-sale restrictions other than tie-ins and price fixes.See section below captioned Mallinckrodt background. In the course of restating the patent exhaustion doctrine, the Court held that it is triggered by, among other things, an authorized sale of a component when the only reasonable and intended use of the component is to engage the patent and the component substantially embodies the patented invention by embodying its essential features. The Court also overturned, in passing, that the exhaustion doctrine was limited to product claims and did not apply to method claims.

Factual background LG Electronics (LGE) owned several patents on methods and systems for processing information. It entered into two contracts with Intel. In the License Agreement, LGE authorized Intel to make and sell microprocessor products using the patented inventions. Moreover, the License Agreement expressly stated that no license was granted to any third party for combining licensed products with other products (for example, for combining Intel microprocessor products with other parts of a computer). The License Agreement also provided, however, "Notwithstanding anything to the contrary contained in this Agreement, the parties agree that nothing herein shall in any way limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products."

In the Master Agreement, LGE required Intel to give its customers notice that the patent license does not extend to any product made by combining a licensed Intel microprocessor product with any other product (for example, a computer). The Master Agreement also provided that its breach would have no effect on the License Agreement and would not be grounds for its termination. Apparently, LGE was willing to allow Intel's customers to combine the microprocessor products with products not licensed by LGE, but only upon payment of a further royalty to LGE for the right to do so. This point is not discussed in the Court's opinion, which recites the facts only in very limited terms because the record was under seal to protect trade secrets.

Quanta Computer purchased licensed Intel microprocessor products and proceeded to manufacture computers containing them. In doing so, Quanta followed Intel's specifications, which in turn led to practice of the patented methods and making the patented systems that LGE licensed to Intel––since that was the way Intel had designed its microprocessor products. (The trial court found that the Intel microprocessor products were without any reasonable noninfringing use.) LGE then sued Quanta for patent infringement.

Quanta prevailed in the district court under the exhaustion doctrine, but on appeal the Federal Circuit held that the exhaustion doctrine did not apply because of the statement in the Master Agreement that combination products were not licensed, given the Federal Circuit's 1992 ruling in Mallinckrodt, Inc. v. Medipart, Inc. that a seller of patented goods could by notice impose a post-sale restraint on its customer's use of the goods. Additionally, the Federal Circuit held that the exhaustion doctrine did not apply, in any event, to method patents.

Mallinckrodt background In Mallinckrodt, Inc. v. Medipart, Inc., the Federal Circuit had held that patent owners could condition the sale of patented goods with a restrictive notice and thereby restrict the disposition of the goods by the purchasers, with the exception of antitrust law violations, such as price-fixing and tie-in restrictions,Richard H. Stern, Quanta Computer Inc v LGE Electronics Inc—Comments on the Reaffirmance of the Exhaustion Doctrine in the United States , 527. or violations of "some other law or policy."Mallinckrodt, 976 F.2d at 708. More specifically, the Mallinckrodt court had said, "Unless the condition violates some other law or policy (in the patent field, notably the misuse of antitrust law)," patent owners, licensees and downstream purchasers "retain the freedom to contract concerning conditions of sale".

The Federal Circuit went on to say that "[t]he appropriate criterion" in determining whether "a restriction or condition . . . placed upon the sale of a patented article" is valid "is whether [the patentee's or licensor's] restriction is reasonably within the patent grant, or whether the patentee has ventured beyond the patent grant and into behavior having an anticompetitive effect not justifiable under the rule of reason."Mallinckrodt, 976 F.2d at 708–09. According to the court, the tests for restrictions and misuse were alike, outside the tie-in and price fixing area: "To sustain a misuse defense involving a licensing arrangement not held to have been per se anticompetitive by the Supreme Court, a factual determination must reveal that the overall effect of the license tends to restrain competition unlawfully in an appropriately defined relevant market."Mallinckrodt, 976 F.2d at 706 (quoting Windsurfing Int'l, Inc. v. AMF, Inc., 782 F.2d 995, 1001–02 (Fed. Cir. 1986)).

This Federal Circuit test is contrary to many decisions of both the Supreme Court and other courts of appeals. For example, in Zenith Radio Corp. v. Hazeltine Research, Inc.,. the Supreme Court addressed the legality of licenses under which royalties were paid on total sales of all products, irrespective of whether the licensor's patents covered all products. The Court held that such licensing was permissible when the licensor and licensee adopted it for mutual convenience to simplify administration of the license,Zenith, 395 U.S. at 136 ("If convenience of the parties rather than patent power dictates the total-sales royalty provision, there are no misuse of the patents and no forbidden conditions attached to the license."). but it was impermissible for the licensor to insist upon it over the licensee's opposition.Zenith, 395 U.S. at 139 ("But we do not read Automatic Radio to authorize the patentee to use the power of his patent to insist on a total-sales royalty and to override protestations of the licensee that some of his products are unsuited to the patent or that for some lines of his merchandise he has no need or desire to purchase the privileges of the patent. In such event, not only would royalties be collected on unpatented merchandise, but the obligation to pay for nonuse would clearly have its source in the leverage of the patent. We also think patent misuse inheres in a patentee's insistence on a percentage-of-sales royalty, regardless of use, and his rejection of licensee proposals to pay only for actual use."). Such conduct was misuse, the Court held, but not an antitrust violation unless the other elements of an antitrust violation were also shown, such as market power.Zenith, 395 U.S. at 140 ("if there was such patent misuse, it does not necessarily follow that the misuse embodies the ingredients of a violation of either § 1 or § 2 of the Sherman Act, or that Zenith was threatened by a violation so as to entitle it to an injunction under § 16 of the Clayton Act.").

Earlier, in Brulotte v. Thys Co.,. the Supreme Court held that it was patent misuse if, without more, a patentee charged royalties that extended beyond the statutory term of the patent. In National Lockwasher Co. v. George K. Garrett Co., the United States Court of Appeals for the Third Circuit held that a patentee misused its patent by requiring licensees to agree not to deal in the technology of the patentee's competitors.National Lockwasher Co. v. George K. Garrett Co., 137 F.2d 255, 256-57 (3d Cir. 1943) (patentee misused patent because patentee was "attempting by means other than that of free competition to extend the bounds of its lawful monopoly to make, use and vend the patented device to the extent where such device would be the only one available to a user of such an article. This monopoly is obviously not covered by the patent."); accord Thus, in these cases, among many others, the Supreme Court and other federal courts had found misuse in cases not involving price fixing or tie-ins, and had not required any rule-of-reason or relevant-market analysis.

Other Federal Circuit decisionsSee, e.g., U.S. Philips Corp. v. International Trade Comm'n, 424 F.3d 1179, 1185 (Fed. Cir. 2005) ("If the particular licensing arrangement in question is not one of those specific practices that has been held to constitute per se misuse, it will be analyzed under the rule of reason. We have held that under the rule of reason, a practice is impermissible only if its effect is to restrain competition in a relevant market.") (citations omitted); followed the Mallinckrodt approach, which at the very least diverged from Supreme Court decisions.One commentator at the time of the Mallinckrodt decision referred to it as inaugurating the demise of the exhaustion doctrine in the United States, Richard H. Stern, The Unobserved Demise of the Exhaustion Doctrine in US Patent Law: Mallinckrodt v. Medipart , 15 460 (1993). Accordingly, when certiorari was granted in Quanta, it was widely surmised that the Supreme Court would overturn Mallinckrodt, which many (including the United States Solicitor General Jeffrey Wall,The United States Solicitor General filed an amicus curiae brief on the merits stating, "The test adopted by the Federal Circuit in Mallinckrodt thus reflects a fundamental misunderstanding of the role and scope of the patent-exhaustion doctrine. ... The court of appeals' approach cannot be reconciled with those [Supreme Court] precedents." Brief for United States as amicus curiae in Quanta, at 23; see also id. at 6 ("In recent years, the first-sale doctrine has evolved in the Federal Circuit in a manner that is at odds with this Court's precedents."); id. at 22 ("The Federal Circuit misreads Univis as standing only for the proposition that restrictions that have been found to be unlawful restraints on trade in the patent context, such as "price-fixing or tying" arrangements, cannot be enforced in a patent-infringement suit."); id. at 30 ("The judgment below rests on the same erroneous understanding of patent exhaustion that infuses the Federal Circuit's approach to this area of the law."). viewed as inconsistent with Supreme Court precedent.Thus, Holman's Biotech IP Blog said: "Many people viewed Quanta as an important opportunity for the Supreme Court to address the viability of Mallinckrodt (976 F.2d 700), a 1992 Federal Circuit decision which held that the doctrine of patent exhaustion applies only to unconditional sales, and that a patent owner is thus permitted to impose post-sale restrictions on purchasers of a patented product by providing purchasers with notice to that effect, and enforce those restrictions under the patent laws. Many, including the Solicitor General, argue that Mallinckrodt should be overruled, and that the decision conflicts with Supreme Court precedent, particularly the 1942 Univis decision, which they interpret as mandating a doctrine of patent exhaustion that bars the enforcement of such restrictions by means of a patent enforcement action."       An O'Melveny & Myers commentary advised the law firm's clients: "As set out by the Solicitor General, the Federal Circuit has once again adopted a formalistic rule that does not advance the interest of patent law as articulated by Supreme Court precedent. Indeed, there seems little doubt that the Solicitor General's views will prevail on the merits, and that the Supreme Court will again reverse the Federal Circuit."