If you are a patent licensee, are you permitted to sell your products without the risk of exposing your customers to patent infringement or royalty claims from the patentee? The recent ruling from the US Supreme Court in Quanta Computer, Inc. v. LG Electronics, Inc. clarifies a patent licensee’s position by finding that the patent exhaustion doctrine applies to method patents. According to this decision, if a licence agreement authorizes the sale of components that “substantially embody” a patented method, then the patent holder will not be entitled to collect further royalties from downstream purchasers.

LG licensed three computer chip and system patents to Intel Corporation. Under the terms of the licence agreement, Intel was authorized to make and sell its own microprocessors and chipsets that use the LG patents. The agreement also permitted Intel to “make, use, sell (directly or indirectly), offer to sell, import or otherwise dispose of” its own products practising the LG patents. The agreement between LG and Intel disclaimed any licence to downstream users if they were to combine the licensed products with non-LG or non-Intel products.

Intel and LG had entered into a separate agreement that required Intel to give its customers written notice that the licence did not extend to a product made by combining an Intel product with a non-Intel product. A breach of that agreement, however, did not terminate the licence agreement.

Quanta purchased Intel microprocessors and chipsets, then manufactured computers using Intel parts, without modification, in combination with non-Intel components in ways that practise the LG patents. LG sued Quanta, alleging that the combination of the Intel products with non-Intel memory and buses constituted patent infringement.

The Supreme Court found in favour of Quanta, concluding that LG could no longer assert its patents against Quanta. As part of its analysis, the Supreme Court considered the following:

  • Does the patent exhaustion doctrine apply to method claims?
  • What triggers patent exhaustion?
  • Did an authorized sale occur?

Does Patent Exhaustion Apply to Method Claims?

Under the doctrine of patent exhaustion, the “initial authorized sale of a patented item terminates all patent rights to that item.” LG argued that the doctrine does not apply to method claims, because method patents are linked to a process as opposed to a tangible article — and therefore they could never be exhausted through a sale.

While the Supreme Court accepted that a patented method may not be sold in the same way as an article or device, methods could still be “embodied” in a product and the sale of that product would exhaust patent rights. Otherwise patentees would be able to circumvent the doctrine simply by inserting method claims into the patents, and expose downstream purchasers to liability.

What Triggers Patent Exhaustion?

The court observed that the Intel microprocessors and chipsets could not function until they were connected to buses and memory in a computer system. Because the components had no reasonable non-infringing use and included all the inventive aspects of the patented methods, the court found that the Intel components “substantially embodied” the LG patents. Consequently, it determined that the exhaustion doctrine was triggered by the sale of the Intel components.

Did an Authorized Sale Occur?

The court then considered whether Intel’s sale to Quanta exhausted LG’s patent rights. LG argued that the sale to Quanta was not authorized by the licence agreement. However, the court found that the agreement did not restrict Intel’s right to sell its microprocessors and chipsets to purchasers who intended to combine them with non-Intel parts.

LG tried to rely on the clause in the licence agreement that disclaimed any downstream licence in the circumstances, but the court held that Quanta’s right to practise the patents was based on exhaustion and not on implied licence. Since it found that the agreement authorized Intel to sell products that practised the LG patents, the court determined that the patent exhaustion doctrine prevented LG from further asserting its patent rights against Quanta and other downstream purchasers of the Intel products.

McCarthy Tétrault Notes:

In light of this decision, current licence agreements should be reviewed carefully with the extended notion of exhaustion in mind. If a licence agreement excludes the right to sell, or provides for limited rights to sell, the licensor may be entitled to royalties or damages from unauthorized purchasers since the exhaustion doctrine only applies to authorized sales. If the agreement provides for broad rights to sell, the licensor may consider increasing the royalties payable by the licensee to take into account any unrecoverable royalties from downstream customers.