I was on a panel at the Patent Law in Global Perspectives Seminar on October 20 at Stanford Law School, discussing the implications of Impression Products, Inc. v. Lexmark, 581 U.S. ___, 137 S. Ct. 1523 (2017), for patent enforcement and licensing. The panel was chaired by Stanford Law Professor Phillip Malone, with Case Western Reserve University Law Professor Aaron Perzanowski, Head of Samsung’s U.S. IP Center Ken Korea, and Google’s Head of IP Transactions John LaBarre. That conversation produced insightful analysis of the Lexmark decision. My take away follows:
In Lexmark, decided in May, the Supreme Court voided a post-sale single-use patent license restriction on printer cartridges sold to consumers, holding that the sale of an item exhausts the seller’s patent rights in the item, leaving nothing to license. This means Lexmark cannot sue cartridge resellers for patent infringement when they refill and resell patented items previously sold in an authorized manner since the rights attached to those patents are exhausted at the first authorized sale. The question then follows: how might patent owners who want to retain some control over their products react to Lexmark? Two examples and a warning come to mind…
In Lexmark, the Supreme Court wrote that its decision on patent exhaustion did not address post-sale restrictions made by contract under state law. But a seller of printer cartridges, may not, as a practical matter, want to sue myriad customers that sell used products to “re-fillers”. What the original seller really wants to do is stop competitorsfrom reconstructing or repairing products (e.g., re-filling used cartridges with ink).
Prior to Lexmark, post-sale license restrictions permitted suit against competitors for patent infringement (which does not require proof of notice or intent). But now, consider as an alternative these three steps as another way to enforce post-sale restrictions after Lexmark under the common law: 1) sell an item subject to a contractual single-use restriction at a lower price than products whose use is unrestricted. Lexmark practiced this model for post-sale license restrictions presumably for consideration and business justification, among other things, for the restricted license, but a seller can use the same model to likewise provide consideration and business justification for contract limitations on re-sale. 2) Clearly label or differentiate the actual items distributed in the marketplace in each category (restricted or unrestricted) to give the consuming public and potential competitors notice of the contract restriction on each item. 3) Give potential purchasers of used products actual notice of the restriction. If competitors are on notice of the contract restriction against resale with consumers, and they purchase used items anyway, they are subject to suit for tortious interference with the seller’s contracts with its purchasers. Tortious interference with contract is a common law claim that can be brought in state court. State court proceedings are often faster and cheaper than federal court litigation. Common law damages include lost profits from lost sales and price erosion, as well as punitive damages. Pennzoil v. Texaco was a tortious interference case that yielded a $10 billion remedy. In addition, deliberately encouraging customers to breach their contracts may also give rise to common law or statutory unfair competition claims (for example, Chapter 93A of Massachusetts General Laws, provides for double damages for unfair business practices). Relying only on the contract also streamlines enforcement by taking patent infringement, validity and enforceability issues out of the case. So use of state law to enforce product restrictions may ultimately prove more effective and less expensive than patent infringement lawsuits when notice is given of the restriction.
By way of an entirely different example, a seller of expensive equipment finances its customers’ purchases by leasing. The seller, however, depends on revenue from after-market service, and uses its patents to refuse to sell parts to independent service organizations (“ISO”) and restrict their access to the leased equipment. Does the lease exhaust the seller’s rights in the equipment? If the customer purchases the replacement parts does that exhaust the seller’s rights in the parts under Lexmark?
There is a body of law that allows some leases to be treated as sales (e.g., for usury when used to finance what amounts to a purchase). Regardless of state laws, the Supreme Court may not find the substance of a lease transaction substantively different enough from a sale to prevent exhaustion. But what if a seller structures a transaction as a license? License transactions per se were not discussed by Lexmark. Licenses have long existed under patent law, and even an exclusive license is distinct from a sale. Moreover, in certain areas, such as software, licenses are used to distribute product to consumers; including “seat licenses”, which restrict use to a designated number of users. Ideally, license restrictions should have strong enough business reasons to support them to outweigh potential adverse effects on competition (that is, make them ‘reasonable restraints’ on trade). For example, consider if a license restriction requiring factory authorized service to maximize the product’s condition when returned is reasonable? Another idea is that the license might state that if non-factory service is used, the licensee must convert the “license” into a “purchase” at a higher price. In addition, pricing the license commensurate with the value of “use” (rather than cost of purchase financed at market interest) will help thwart a finding that the transaction is a sale, as well as justify the restriction as a reasonable restraint on competition in the market.
But will the ‘license model’ work? Query whether a consumable product (food, fuel, medicine, etc.) can be distributed to consumers by license, as opposed to sale? What if the consumable part of the product is sold (the ink), but the cartridge is only licensed and must be returned? Will the Supreme Court allow Lexmark to be circumvented by re-characterizing the transaction legally even though substantively it is unchanged? The point of these two examples is that there are ways to approach the market after Lexmark to maintain some control over products that are substantively different from the post-sale patent license restrictions in Lexmark.
A word of warning: depending on 1) the market; 2) the impact of any business restriction on competition; and, 3) the justification for the restriction and/or benefit to the market; there could be an antitrust or competition issue. After FTC v. Actavis, Inc., 570 U.S. ______, 133 S.Ct. 2223 (2013), antitrust liability can be alleged even if the patent is not shown to be invalid. Lexmark took away any immunity defense based on proper exercise of post-sale license restrictions under a patent that would be immune from antitrust liability. See, e.g. and compare Kodak v. Image Technical Services, Inc., 504 U.S. 451 (1992) and In re Independent Service Organizations, 203 F.3d 1322 (Fed. Cir. 2000). So, there is a solution to every problem, but any solution has to address both the business goal and the legal risk: “…(e)very form of refuge has its price.” Eagles, Lyin’ Eyes, 1975.