In today’s push to compete globally, many companies search for new products to fuel their expansion into new markets. Frequently, this quest involves licensing rights to products developed by others. Although such licenses are sometimes worldwide in scope, more often they are limited by territory, with the licensee acquiring rights in certain countries of interest and the licensor retaining the right to exploit the technology elsewhere. Although such transactions can prove to be quite valuable, the licensee’s return on investment may be subject to price erosion from parallel imports, that is, products first sold in a foreign county and then imported for resale into the country of interest. Because of non-uniform application of the patent exhaustion doctrine, parallel imports are legal in some countries but not in others. Generally, the patent exhaustion doctrine (or the “first sale” doctrine) provides that when the owner or licensee of a patent sells a patented product, it has exhausted the patent right attached to the product in exchange for the benefit received from the first sale. In turn, the buyer of the product enjoys an implied license to resell the article without such sale being an infringement of the patent.

To illustrate, a company may successfully negotiate an exclusive license to market a product in a country where the product enjoys strong patent protection. In an effort to protect against knockoffs in that country, the company may obtain from the licensor a commitment to defend the product and assert patent rights against any infringers. Despite this precaution and patent protection, however, if the licensor retained rights to the technology outside of the territory licensed to the company, the licensor itself may manufacture and sell the same product in other parts of the world, or may license others to do so. If a price differential exists between the company’s selling price and the price commanded by the licensor or its other licensees elsewhere in the world, purchasers may choose to simply import the lowerpriced products from other countries and sell them in direct competition with the company’s products. In some countries, the sale of such parallel imports is legal; in others, it is not.

The reason this occurs is that, although many countries apply some form of the patent exhaustion doctrine, the laws are not uniform regarding the scope of the doctrine. For some countries, such as the United States, the patent exhaustion doctrine only applies where the first sale was made domestically, that is, within the United States. The doctrine was recently discussed and applied by the U.S. Court of Appeals for the Federal Circuit in a series of cases addressing the legality of importing refurbished disposable cameras into the United States. The Federal Circuit articulated the patent exhaustion affirmative defense, holding that the “unrestricted sale of a patented article, by or with the authority of the patentee, exhausts the patentee’s right to control further sale and use of that article by enforcing the patent under which it was sold.” Jazz Photo Corp. v. United States, 439 F.3d 1344, 1350 (Fed. Cir. 2006). The court reasoned that “when a patented devise has been lawfully sold in the United States, subsequent purchasers inherit the same immunity under the doctrine of patent exhaustion.” Id. Applying the exhaustion doctrine together with the permissible repair doctrine, the Federal Circuit affirmed the Court of International Trade’s determination that certain cameras originally sold in the United States, later refurbished overseas and then imported back into the United States for sale, were outside the scope of patent protection and could be legally distributed in the United States. Id. The patent exhaustion doctrine does not apply in the United States, however, where the first sale occurs outside the United States. See id. at 1351-52; Jazz Photo Corp. v. Int’l Trade Comm’n, 264 F.3d 1094, 1105 (Fed. Cir. 2001) (“To invoke the protection of the first sale doctrine, the authorized first sale must have occurred under the United States patent”).

In contrast, in other countries such as Japan, the patent exhaustion doctrine applies where the first sale was made internationally, such that any sale worldwide serves to exhaust patent protection in Japan. Thus, exhaustion of patent rights occurs in Japan once the product is sold or put into the stream of commerce by the patentee or its licensees anywhere in the world. The Supreme Court of Japan, in Jap-Auto Products v. BBS, discussed the policy behind Japan’s adoption of international exhaustion, explaining that parallel imports promote price competition. Such imports should not be hindered, the Court explained, where patentees have already gained reward for their inventions through sale of products somewhere in the world. Jap-Auto Prods. v. BBS, 79 JPTOS 721, (1997).

Notably, however, although the Japanese Court appeared to focus exclusively on the consumer benefit derived from parallel imports, it also recognized a narrow limitation to international exhaustion. In particular, the Japanese Court provided that a contractual restriction precluding resale of the products in Japan could be effective to maintain the enforceability of the patent rights granted in Japan, notwithstanding a lawful transfer of the patented product to a third party in a foreign country. Under this exception, a patentee does not grant an implied license for a parallel import if the patentee explicitly excludes Japan from the permissible sales territory, and provides notice of the restriction on the products. In other words, Japanese patent rights will generally be exhausted as to any products manufactured and sold by the patentee or its licensees anywhere in the world, unless the resale of those articles in Japan is expressly forbidden by the patentee, and such restriction is marked on the products themselves.

The international exhaustion doctrine, as applied in Japan, may also be tempered by a recent decision in Canon, Inc. v. Recycle Assist Co., Ltd., in which the Intellectual Property High Court of Japan articulated two situations where the doctrine would not be applied. The court held that a patent right is not exhausted and the Japanese patent may still be enforced: (1) where the patented products are reproduced and reused after their normal durable period and after they would otherwise no longer function; and/or (2) where a third party processes or replaces all or part of an essential element of the patented invention in the patented product. IP High Court, Grand Panel Decided Jan. 31, 2006 Case No, 2005(ne)10021. This case is currently on appeal to the Japanese Supreme Court.

Although international trade is expanding, and efforts have been made to harmonize applicable laws, currently no uniform rule exists as to the application of the patent exhaustion doctrine, as is illustrated by the differences between United States and Japanese law. Because of non-uniform patent exhaustion laws, successfully limiting a company’s exposure to parallel imports and the attendant risks of price erosion starts with an assessment of the law of the countries in which a company seeks to license patents. If a country of interest follows an international exhaustion approach like Japan, any patent license negotiation should address means to protect against parallel imports and potential price erosion. For example, if a company seeks rights in Japan, and no other existing licensees exist and the products are not already being sold in other countries, then the licensor may agree to prohibit other licensees from selling products in Japan. On the other hand, if other licensees are already selling the product outside Japan, then a financial accommodation could be built into the license agreement to maintain profitability should price competition from parallel imports occur. Any contract provisions affecting the sales and pricing of goods, such as to protect against price erosion, however, also should be carefully drafted to comply with any applicable antitrust regulations that exist in the countries implicated. Although the application of the patent exhaustion doctrine is nonuniform, various methods exist to help reduce the risk of price erosion from parallel imports and maximize the profitability of patent licenses worldwide.