In its May 30, 2017 decision in Impression Products v. Lexmark International, the U.S. Supreme Court expanded the scope of the patent exhaustion doctrine – a decision that could have substantial effects on patent owner rights, licensing practices, and what companies and consumers may do with products they buy. Ropes & Gray IP litigation counsel Matt Rizzolo (Washington, D.C.) and associate Henry Huang (Silicon Valley) discuss the Court’s ruling and its implications.
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Matt: Hello and welcome to a special follow-up podcast in our Supreme Court series. I’m Matt Rizzolo, IP litigation counsel in the Washington, D.C. office of Ropes & Gray. Today’s podcast topic is the Supreme Court’s recent ruling in Impression Products v. Lexmark. Joining me again today is my Silicon Valley colleague Henry Huang. Henry is an IP litigation associate and a former district court and Federal Circuit clerk. You might have heard our podcast a few weeks ago previewing this case. Today we’ll offer insights into the Court’s ruling and discuss how this might affect you—as a consumer, a patent owner, or a reseller of products.
Let’s start with a quick recap. Henry—remind us what this case is about.
Henry: This case is about patent exhaustion and whether a patent owner can restrict what happens to patented products after they’re sold. Lexmark is a printer company that sells toner cartridges and has patent rights on those cartridges. Lexmark tried to limit what customers could do with their cartridges after buying them, such as preventing customers from reselling or reusing them. Impression is a small company that refurbishes and resells cartridges, including Lexmark’s products. Lexmark sued Impression, and the case went up to the Federal Circuit, which gave Lexmark a win ruling that no rights were exhausted due to Lexmark’s sales in the U.S. or in other countries. Then the Supreme Court took the case.
Matt: The Supreme Court was almost unanimous in reversing the Federal Circuit, is that right?
Henry: Yes. The Court issued a near-unanimous decision that greatly expands patent exhaustion and limits patent rights. As I mentioned, there were two issues about exhaustion—one related to conditional sales here in the U.S., and one related to sales made abroad. On the first issue, about domestic exhaustion, the Court ruled 8-0 for Impression (Justice Gorsuch did not participate). The Court held that when a patentee sells a product, it loses all rights to control what happens to that product afterwards. On the second issue, about international exhaustion, the Court went 7-1 for Impression, holding that selling products in another country also exhausts U.S. patent rights. Justice Ginsburg dissented on the second issue because she believed that U.S. patent law should not affect actions in other countries, whose patent laws may differ from those in the U.S.
Matt: Reading the opinion, it seems like a big part of the decision was an issue we mentioned in our first podcast—the historical legal source of the patent exhaustion doctrine.
Henry: That’s right. Impression claimed that patent exhaustion is based on court-made common law dating back hundreds of years, which says that there can be no post-sale restrictions on personal property. Lexmark, on the other hand, argued that patent exhaustion comes from the Patent Act, and specifically 35 U.S.C. § 271(a), which prevents others from making, using, or selling a patented product “without authority.” The Supreme Court agreed with Impression, and the Court said that common law doesn’t distinguish between authorized sales here or in other countries. According to the Court, “An authorized sale outside the United States, just as one within the United States, exhausts all rights under the Patent Act.” In fact, Justice Roberts said that exhaustion has “an impeccable historic pedigree.” But while the Supreme Court stressed the historical source of the patent exhaustion doctrine, it seems pretty clear that this decision changes the patent licensing landscape.
Matt: I agree. It is a bit too early to say, but Lexmark could affect a lot of patent ownership and licensing practices. Patent owners will still want to maintain control over their products and maximize their revenue streams, without running afoul of the law. One issue that the Court left open is what constitutes an “authorized sale.” For example, if a company sells products, what happens if it transfers its patent to a subsidiary? Is the first company no longer the patentee, so that its sales are not “authorized” under the patent? If so, then the subsidiary can still sue downstream customers. So companies might try to create new ways to transfer ownership of patents to avoid this rule.
Henry: There’s also a particularly important part of the opinion where the Supreme Court reaffirms the difference between “sales” and “licenses.” The Court said, “A patentee can impose restrictions on licensees because a license does not implicate the same concerns about restraints on alienation as a sale.” This indicates that it’s still possible to impose post-sale restrictions in patent licenses, such as preventing licensees from re-selling the product or using it in certain markets. So one question that commentators have raised is whether certain companies may change their business models and simply say they are “licensing” their products to customers, instead of “selling” them. We could see a lot more product “licenses” instead of sales to try to avoid triggering patent exhaustion.
Matt: It seems like those types of transactions might be easier to do in some industries rather than in others. What industries do you think will be principally affected by this case?
Henry: It is hard to say this early, but we have some idea, partly because of the companies who filed amicus briefs with the Supreme Court. As we pointed out in the first podcast, a bunch of retailers supported Impression because they sell or re-sell products, some of which have many patented components. The same is true for some technology companies like Intel, who have complex supply chains across the world. On the other hand, pharmaceutical and medical device companies sided with Lexmark because they want stronger control over their products. Some news stories are already predicting that drug prices will come down because it might be easier to import cheaper drugs from other countries, though there are still are still a number of FDA rules that restrict that.
Matt: That’s a very good point—those existing FDA rules may prevent arbitrage between the foreign and domestic drug markets despite this ruling. For other industries, though, I imagine that this type of parallel importation may become much more appealing—especially importation from countries where certain types of patent protection may be harder to obtain. There’s a possibility that we could see increased activity in Section 337 actions at the International Trade Commission in D.C. as a result. I could certainly envision some companies arguing that such parallel importation is an unfair trade practice prohibited by Section 337.So Henry, what happens to existing licenses? What if I already have a license or contract that has post-sale restrictions, like Lexmark or Impression?
Henry: It depends on which side you’re on. If you’re the patent owner, then you might have just lost a lot of your enforcement rights. Lexmark can’t sue companies who re-sell their print cartridges. Of course, second-hand sellers like Impression now have much greater freedom to operate. Some IP licenses will have to be renegotiated, and several of our clients have asked for guidance on what to do now.
Matt: What else can patent owners do to protect their IP? If they can’t sue re-sellers or downstream customers for infringement because the patent owners have already exhausted their rights, what options do they have?
Henry: There is still the possibility of suing for breach of contract. The Supreme Court suggested this option when it said that “whatever rights Lexmark retained are a matter of the contracts with its purchasers, not the patent law.” However, as we noted last time, contracts are limited by the doctrine of privity—Lexmark would not have been able to sue Impression in this case, for example, because they never signed a contract together. This is a big reason why companies will have be very careful with their contracts now, or come up with new ideas for controlling their products. There’s also the possibility that parties will begin to try to structure their contracts to create privity or third-party beneficiary issues in an effort to allow them to enforce the contracts more broadly; such creativity is likely to become the topic of future litigation.
Matt: Now I suppose we’ll have to wait and see what companies do to adjust their patent enforcement strategies, and whether prices for consumer goods will change in some industries. Henry, thanks for joining me for this follow-up Supreme Court podcast. Until next time, please visit our Capital Insights page at www.ropesgray.com for more news and analysis on noteworthy issues arising out of Washington, D.C.