The U.S. Supreme Court’s June 2008 unanimous decision in Quanta Computer, Inc. v. LG Electronics, Inc., 128 S.Ct. 2109, re-charged the doctrine of patent exhaustion, whereby the first unrestricted sale of a patented item terminates the patent owner’s control over any patent rights in the item sold. While this result is noteworthy to most licensors, not every licensed sale will invoke the patent exhaustion doctrine. Only those sales which are unconditional in the terms of their first transfer are at risk, despite the presence of other restrictions or covenants on subsequent uses of the invention.

Moreover, even if patent rights in the items sold are lost through the doctrine of exhaustion, the court left open the potential for collecting damages under a breach-of-contract theory for violating the other restrictions. The Ccurt’s decision also left intact previous case law in Monsanto Co. v. Scruggs, 459 F.3d 1328 (Fed. Cir. 2006) that the “first sale” doctrine of patent exhaustion does not apply to the sale of progeny of a replicating technology, e.g., a second generation seed, which has never itself been sold.

The licensed technology in the Quanta case included three patents covering a system and method for increased computer processing efficiency using a microprocessor that prioritizes “write” and “read” requests over a series of bus connections to other computer components. The LG-Intel License Agreement provided that any third-party purchaser of Intel licensed products did not have a license to the LG technology if that purchaser combined the products with non-Intel products. The License Agreement also contained a clause that notwithstanding anything to the contrary, nothing shall in any way limit or alter the effect of patent exhaustion.

In a concurrent Master Agreement between LG and Intel, Intel promised to provide written notice to purchasers that no license from LG would be granted by mere purchase of the products from Intel and re-combination with non-Intel products and that direct licensing from LG would be required. However, the sale to Intel under the original license was not conditioned on such compliance. Also, it was specified that a breach of the Master Agreement would have no effect on, and would not be grounds for, termination of the License Agreement.

Quanta was one such company that purchased Intel products with the LG technology, received the required notice from Intel, and nonetheless incorporated LG products with non-Intel products without obtaining a separate license agreement from LG. The District Court ruled in favor of Quanta and the other defendants on summary judgment that there was no infringement liability because patent exhaustion had been triggered upon the first sale to Intel of products that substantially embodied the patented invention. However, on reconsideration, the court denied summary judgment as to the method claims.

The U.S. Court of Appeals for the Federal Circuit affirmed the District Court ruling that the method patents were not exhausted, but reversed the lower court’s ruling on exhaustion of the apparatus claims. The Federal Circuit noted that patent exhaustion did not apply because the licensing provision stating that no license was granted to third parties who combined the Intel products with non-Intel products sufficiently restricted the initial transfer of the technology to be a “conditional” sale.

The Supreme Court reversed the Federal Circuit on both points, holding that authorized sale of a product that substantially embodies essential features of the patented invention, even if in an unfinished state, and whose only reasonable and intended use is to practice the patent, will exhaust the patent holders’ right to control the article after sale, heavily relying on the court’s 1942 Univis Lens case. The court also held that the exhaustion doctrine applies equally to apparatus and method claims.

The court found that the grant of the right to Intel to re-sell the products embodying the LG patents was authorized under the License Agreement, and was not conditioned upon the separate contractual obligation to provide notice to LG. Justice Clarence Thomas pointed out that “[n]othing in the License Agreement restricts Intel’s right to sell its microprocessors and chipsets to purchasers who intend to combine them with non-Intel parts.” To the contrary, the agreement contained other contractual provisions regarding non-termination for breach and non-limitation of the effect of patent exhaustion.

After the Quanta decision, there is a very real possibility that many similarly structured licenses may be vulnerable to loss of downstream user control. Therefore, licensors should take a second look at their agreements and take appropriate actions to remedy any potential weaknesses in language and/or restrictive conditions. This review is even more imperative for biotech patent holders whose inventions are capable of replication, and therefore longer term loss of control, such as nucleic acids, cellular cultures, transgenic animals or plants.

At first blush, Quanta seems to indicate that patentees can only control their products through patent law until the first sale, and they must rely on contract law for further controls. Due to the requirements for direct privity between parties in contractual obligations and the greater forms of relief available under patent law, including injunction, the result in Quanta is troubling.

The Quanta decision does provide some hope for patent licensors in Footnote 7, indicating that because LG’s complaint included no breach-of-contract claim, the court declined to comment on whether future contract damages would be available even though exhaustion may operate to eliminate patent damages. Moreover, a properly drafted primary license agreement can still effectively perpetuate patent control over the invention as long as authorization for future undesirable activities is strictly a condition of the original grant of license.

With respect to the unique nature of replicating biotech inventions, there is still room for consistency between Quanta and the industry favorable 2006 Federal Circuit decision in Monsanto. That case stated that the fact that a patented technology can self-replicate does not give the purchaser the right to use replicated copies of the technology. The doctrine of patent exhaustion would only apply to the first sale of the embodiment of the replicable technology, and not to subsequent generations. “Applying the first sale doctrine to subsequent generations of self-replicating technology would eviscerate the rights of the patent holder.”

Any licenses to replicating organisms containing patented technology should still contain clear restrictions on the buyer’s right to maintain its license to the product, including restrictions against unauthorized replication, use, administration or re-sale, in view of Quanta. However, the progeny of such inventions should be further insulated from a claim of patent exhaustion due to the prior, unchanged holding in Monsanto.

The Supreme Court made clear in Quanta that the early concept of patent exhaustion is alive and well, even when the products first sold merely embody “essential features” of the patent, as long as the “reasonable and intended use” of the products is to practice the patent, and as long as there is no conditioned restriction on the initially granted patent rights.

However, the case is also instructive for negotiators and drafters to avoid potentially contradictory license terms, i.e., such as “notwithstanding anything to the contrary,” which may appear conciliatory, but can be self-defeating. License agreements intending to control downstream uses and dissemination of even replicable biological materials should include express language that the license is conditioned upon and only authorizes those intended uses in order to avoid a loss of control through patent exhaustion.