BioInsights, Fall 2008 - Issue 10: Quanta Computer, Inc. v. LG Electronics, Inc.: Supreme Court Clarifies that Patent Exhaustion Applies toMethod Patents

September 1, 2008 Advisory

On June 9, 2008, the United States Supreme Court ruled in Quanta Computer, Inc. v. LG Electronics, Inc. that the doctrine of patent exhaustion applies to method patents as well as product and composition of matter patents. Patent exhaustion provides that an authorized sale of an article that substantially embodies a patent exhausts the patent holder's rights and prevents the patent holder from invoking patent law to control post-sale use of the article. This decision will likely have significant implications for biotechnology patent law since it will now be more difficult for patent holders to maintain a claim for infringement down the distribution chain of a product.

LG Electronics, Inc. ("LG") licensed several product and process patents to Intel Corporation ("Intel") in an agreement that authorized Intel to manufacture and sell microprocessors using the LG patents. A separate agreement required Intel to give its customers written notice that the license does not extend to a product made by combining an Intel Product with a non-Intel product, and provided that a breach of the agreement would not affect the license agreement. Quanta purchased microprocessors from Intel, which it used to manufacture a product using Intel parts in combination with non-Intel parts. LG sued, asserting that this combination infringed the LG patents.

The District Court held that because each of the LG patents include method claims, the doctrine of patent exhaustion did not apply because patent exhaustion applies only to apparatus or composition of matter claims. The Court of Appeals for the Federal Circuit (CAFC) agreed with the District Court that patent exhaustion did not apply to method patents and concluded that exhaustion did not apply because LG did not license Intel the right to sell the Intel product to Quanta to combine with non-Intel products. Quanta appealed.

Patent Exhaustion Applies to Method Patents
The Supreme Court, in a unanimous opinion written by Justice Thomas, held that the Patent Exhaustion Doctrine (also known as the First Sale Doctrine) applies to method patents as well as product and composition of matter patents. The Court noted "[i]t is true that a patented method may not be sold in the same way as an article or device, but methods nonetheless may be 'embodied' in a product, the sale of which exhausts patent rights", and that the Court has repeatedly held that method patent rights are exhausted by the sale of "an item that embodied the method." As the Court pointed out, if patent exhaustion did not apply to method patents, patent owners could avoid patent exhaustion entirely by simply including at least some method claims in each patent.

Exhaustion is Triggered when the Product Sold Substantially Embodies the Patent
According to the Court, the holding of United States v. Univis Lens Co. (1942) controlled the facts of the case. In Univis, a patentee's rights in finished eyeglass lenses did not survive a licensee-purchaser's sale of lens blanks to downstream wholesalers and retailers who ground the lenses into finished products. The Court concluded in Univis that the patentee's rights were exhausted because the lens blanks sufficiently embodied the patented lenses such that their only and intended use was to be a finished product. In applying Univis to this case, the Court concluded that the microprocessors Intel sold to Quanta embodied the essential features of LG's method patents. The Intel products "constitute a material part of the patented invention and all but completely practice the patent", and LG did not offer any reason to doubt the conclusion that the only "reasonable use" for the Intel products was to practice LG's patents.

Exhaustion Applies If an Authorized Sale Takes Place
In order for the Patent Exhaustion Doctrine to apply, a sale authorized by the patent holder must occur. Based on the structure of the agreements between LG and Intel, the Court found authorized sales had occurred. The Court found that Intel's sale to Quanta was within the scope of the license from LG, notwithstanding the apparent restriction in both the agreement between Intel and LG as well as the notice about the limitations on the license provided by Intel to Quanta. The Court concluded that LG's patent rights were exhausted by this sale, and LG could not pursue its patent infringement claims against LG.

Although Quanta v. LG did not center around biotechnology, the decision will likely have significant implications for biotechnology patent law. For example, many inventions in biotechnology are analogous to "products" described in the decision. Key ingredients such as nucleic acids, proteins, and other biomolecules are often purchased and combined with additional substances such as solvents, carriers, or vectors in order to produce a product for sale. Unless the products for sale themselves are the subject of patent claims, it will now be more difficult to control the key ingredients through licensing arrangements due to exhaustion of patent rights. Although attempts will likely be made to license around patent exhaustion, licensors should be careful to avoid allegations of patent misuse. Since the patent exhaustion doctrine effectively prevents multiple royalties on products sold, licensors may also attempt to negotiate higher royalties for key ingredients covered by patent claims in order to compensate for loss of post-sale revenue. Finally, since the Court made clear that patent exhaustion applies to method claims (which are often present in biotechnology patents in the form of process and product-by-process claims), it may also be more difficult to limit exhaustion of patent rights through the use of claimed methods, particularly if a product that is sold embodies such methods.