First published in LES Insights

In LifeScan Scotland, Ltd. v. Shasta Technologies, No. 2013-1271 (Fed. Cir. Nov. 4, 2013),1 the Federal Circuit reversed an order granting a preliminary injunction blocking sales of consumable test strips for use in LifeScan's meters because its distribution of meters for free likely exhausted its patent rights. We reported on the district court's order, available at http://lesusacanada.org/featured-articles/2013/lifescan.

LifeScan's U.S. Patent No. 7,250,105 ("the '105 patent") describes and claims an improved method of testing blood glucose embodied in LifeScan's meters and associated test strips for use in the meters. LifeScan provided 60 percent of its meters through distributors that gave them away and sold the remaining 40 percent at below cost. LifeScan sold test strips for use in the meters, however, and sought a preliminary injunction to exclude the manufacture and sale of the competing GenStrip.

The district court considered arguments by the defendants asserting the doctrine of patent exhaustion. This doctrine holds that patent owners can profit from their patents only once. The question raised—particularly for the 60 percent of meters LifeScan distributed for free with an expectation to sell a compatible test strip—was whether it profited such that patent exhaustion applied. The district court decided that patent exhaustion did not apply because the doctrine applied only to a "sale" where the patent owner required "consideration" in exchange for the product. Because the district court held that the transfer of meters at no cost did not exhaust the patent owner's rights, patent exhaustion was not available as a defense and it issued a preliminary injunction in favor of LifeScan.

The Federal Circuit Decision

In its decision, the Federal Circuit recognized that it had to address as a matter of first impression the question of whether patent exhaustion applies to a product distributed for free. It saw the issue differently—"in the case of an authorized and unconditional transfer of title, the absence of consideration is no barrier to the application of patent exhaustion principles." LifeScan had relied on Supreme Court exhaustion cases describing "receipt of ‘consideration' or ‘reward'. . . as supporting exhaustion." The court, however, explained that the Supreme Court has never confined exhaustion to that context. Thus, the Federal Circuit concluded that a patent owner may choose to secure its reward either by demanding a price or by giving the product away, with the hope of a future benefit. And where LifeScan chose to give meters away without charge in order to increase sales of its test strips, it should not be allowed to avoid patent exhaustion.

The court further addressed the nature of the transfer of meters as an unconditional transfer, providing some suggestion how patent owners might avoid patent exhaustion. LifeScan's meters were packaged with a notice that purportedly required customers to use LifeScan's test strips and LifeScan argued it had granted only a conditional license. But LifeScan's reliance on the notice fell short in this case because the court refused to consider such notices unless "in the form of a contractual agreement."

LifeScan raised a number of other arguments why patent exhaustion did not apply, and the court addressed and rejected each one in turn.

LifeScan argued that distribution of its meters, whether by sale or gift, did not trigger exhaustion because the meters did not substantially embody the claims of the '105 patent. The asserted claims were method claims and the issue is governed by the Supreme Court's decision in Quanta Computer v. LG Electronics,2 which clarified the applicable test. In short, the item sold must substantially embody the patent, regardless of whether any additional steps needed to complete the invention are themselves inventive or noninventive. One approach to this inquiry asks whether there are reasonable and intended noninfringing uses, and here, the Federal Circuit held that LifeScan admitted it distributed the meters with the expectation and intent that they be used with its test strips. Although alternative uses might not infringe, because LifeScan did not intend those uses, the court viewed them as irrelevant to the issue of patent exhaustion.

LifeScan also argued that exhaustion did not apply because the meters did not embody essential features of the '105 patent. To identify those features, the court focused on what was inventive—what distinguished the patent claims from the prior art. And by considering the prosecution history, the court determined that the inventive nature came from the meter's comparing function, not the particular strip configuration. So it held that the meters embodied essential features of the '105 patent.

The court noted LifeScan's argument that the strips themselves were separately patentable. Rather than determine whether the strips would have been separately patentable, however, the court considered whether the strips embodied "the inventive features of the claims that were actually allowed by the examiner." The examiner did allow claims directed to the strips themselves and, as discussed above, the court determined that the meter embodied the inventive aspects of the claims. While noting that the analysis would differ if a patent had actually issued on the strips, the court rejected LifeScan's argument that exhaustion could not apply unless the strips were "standard" parts.

Finally, the court noted a problem that would be created if the '105 patent were not exhausted: LifeScan would be able to eliminate competition in the sale of strips even though the strips do not embody the claimed invention and are not themselves patentable. According to the Federal Circuit, such extension of the exclusionary right would improperly extend the patent monopoly.

Strategy and Conclusions

This case demonstrates that patents can be exhausted by a patent owner who authorizes the distribution of products that substantially embody the patent claims at issue even if they do not receive direct compensation for the sale of those products.

As illustrated by the court's analysis and conclusion, the issue of patent exhaustion can be complex and difficult to predict because a variety of legal and factual issues can possibly impact whether a patent owner's rights are exhausted, including (1) the reward the patent owners expect to receive when they distribute or authorize the distribution of products; (2) the manner in which the patent owners intend the item they distribute to be used and whether this use involves additional items that did not come from an authorized sale or distribution; (3) the nature of legal rights and obligations arising from accompanying documents or understandings such as conditional licenses or binding agreements; (4) whether the products have certain functions in the market such as whether they are standard parts or essential features; and (5) patent protection and prosecution history—whether the products have or could have patent protection, separately patented or separately patentable, whether the inventive features of the claims were actually allowed by the examiner, or whether the product embodied the inventive aspects of the claims.