Patent exhaustion: you may be asking yourself, “what does it mean and how does it affect me?” This morning, in the highly anticipated case of Impression Products, Inc. v. Lexmark Int’l, Inc., the U.S. Supreme Court reversed a decision of the Federal Circuit Court of Appeals and ruled that the foreign sale of a patented product exhausts a patent owner’s right to sue for patent infringement in the U.S. In other words, the “patent exhaustion” doctrine is triggered not just by sales of the patented product in the U.S., but also by sales in a foreign country. The ruling, while consistent with recent Court precedent concerning copyright exhaustion, further dilutes the rights of patent holders and could have wide ranging effects hampering innovation.

A U.S. patent entitles the patent holder to exclude others from making, using, offering for sale, or selling its invention throughout, or importing the invention into, the United States. When a patentee sells one of its products, however, the patentee can no longer control that item through the patent laws – its patent rights are said to “exhaust” as a result of its “first sale” of the patented item.

Lexmark designs, manufactures and sells toner cartridges to consumers in the U.S. and abroad. It holds a number of patents covering components of the cartridges and the manner in which they are used. Lexmark sells its cartridges to consumers both at full price with no restrictions on use, or at a discounted price whereby consumers contractually agree to use the cartridge only once and refrain from transferring it to anyone other than Lexmark. Impression Products, like other toner remanufacturers, acquires empty Lexmark cartridges from purchasers both here and abroad, refills them with toner, and then resells them. Lexmark sued Impressions Products for its resale of refurbished toner cartridges.

With respect to the discounted cartridges Lexmark sold to U.S. customers, Lexmark argued that it expressly prohibited their reuse and resale. With respect to the cartridges sold abroad and imported back into the U.S. by Impression Products,., Lexmark contended that this was done without its authority. Thus, its patents, according to Lexmark, were infringed.

The Court, citing its 2013 precedent on copyright exhaustion in Kirtsaeng v. John Wiley & Sons, Inc., ruled that while the Patent Act promotes innovation by allowing inventors to secure financial rewards for their invention, once it sells an item, it has secured that reward. The product has then become the private, individual property of the purchaser, who may transfer or dispose of the product as he or she desires. In other words, the limited power of the patentee to exclude others from making, using, offering for sale, or selling what is claimed in the patent is extinguished, with respect to particular patented products, once it sells those patented products.

A useful illustration helped the Court drive its point home: Shops that restore and resell used cars (think Carmax®) succeed because, so long as those bringing in their cars actually own them, the shop is free to repair and resell those vehicles without the threat of being sued by companies who make the thousands of parts that go into a vehicle. Extending patent protection beyond the first sale of the vehicle would cause the “smooth flow of commerce (to) sputter” and “clog the channels of commerce, with little benefit from the extra control that the patentees retain.”

What are the practical effects of this decision? To begin with, patent holders are not without a remedy. The Court made clear that post-sale restrictions (such as those placed by Lexmark on purchasers of discounted cartridges) can still be enforced through contract law. Thus, Lexmark could sue those who purchased the discounted cartridges with restrictions preventing them from transferring them to anyone other than Lexmark.

The decision also significantly impacts licenses. Once a patent licensee complies with the patentee’s license when selling an item, that patentee has, in effect, authorized the sale. The licensee’s customer is then free to dispose of the product as he or she desires, without the threat of patent infringement. On the other hand, where a licensee breaches the license, both the licensee and its customer are subject to patent litigation. The Court provided the example of a computer developer that licenses a manufacturer to make its patented devices and sell them only for non-commercial use by individuals. If the licensee breaches the license by selling a computer for commercial use, the patentee can sue the licensee and its customer for infringement because the sale can be treated as if no license had been granted. The Lexmark decision is thus a wakeup call to patent holders to ensure that their licenses are up to snuff and contain requirements that licensees place sufficient post-sale restrictions on their customers.