Patent Exhaustion Update: The Federal Circuit Allows Royalties From Different Entities in Supply Chain

March 3, 2015 Advisory

Patent exhaustion, or "the first sale doctrine," requires that the initial authorized sale of a patented item by a patent owner or licensee, terminates their ability to subsequently use their patent rights against that item. Quanta v. LG Electronics, Inc., 533 US 617, 625 (2008). In the Quanta case, LG and Intel arrived at a license agreement whereby LG licensed Intel, but reserved the rights to pursue patent infringement claims against Intel customers who combined the licensed Intel chips with memory to allegedly infringe the patents at issue. The Supreme Court found, however, that LG's infringement claims against its licensee's customers were barred by the doctrine of patent exhaustion: "The authorized sale of an article that substantially embodies a patent exhausts a patent holder's rights and prevents the patent holder from invoking patent law to control post-sale use of the article." Id. at 638.

The extent of authorization may be narrowed. For example, a patentee can license within a particular field of use and then pursue infringers – downstream or otherwise – in another field of use. However, since the Supreme Court's decision in Quanta, it has been well-established that it is very difficult to "contract around" patent exhaustion. Significantly, the Federal Circuit's recent decision in Helferich Patent Licensing, LLC, may provide another methodology by which a patentee may pursue infringers at two levels of the supply chain.

In Helferich, the patentee "painstakingly" engaged in separate licensing campaigns against cell phone manufacturers and content providers. The patents at issue related to methods and systems that send and receive website hyperlinks to an electronic device, i.e., SMS and MMS messaging. A user can then click the link and retrieve the content. Helferich had licensed the cell phone manufacturers on a set of patents and patent claims referred to as Handset Claims. However, their license agreements carved out and reserved specific patents and patent claims in the portfolio (i.e., "Content Provision Claims"). The licenses provided to the cell phone manufacturers were also limited to licensed fields, such as mobile wireless communication devices, and the covenants and releases provided to the cell phone manufacturers operated only to the extent the infringement claim was based on a product within the licensed fields.

At the district court level, the content maker defendants, including Bravo, The New York Times, JC Penny and others, moved for summary judgment of non-infringement based on the defense of patent exhaustion. They argued, and the district court agreed, that Helferich's effort to construct its licensing agreements in such a way as to recover multiple royalties on the same patents from a single sale or use of the products at issue was improper: "All the patents-at-issue require the use of a handset device. HPL licensed its patent to every handset maker . . . Once the handset manufacturers sell the handsets that embody HPL's patents, HPL's patents are exhausted as to all third parties, including Defendants."

On appeal the Court of Appeals for the Federal Circuit reversed. The Federal Circuit panel adjudicated the exhaustion issue based on its understanding that Defendants' position was that Helferich's claims were broadly exhausted because the handsets were licensed and the asserted claims covered the use of the licensed product. Framed as such, the Federal Circuit disagreed:

"The situation, to simplify, involves a single inventor's coming up with two inventions presumed to be separately patentable, one invention to be practiced by one group of users and the other invention by another group, when practicing the second invention in some way contemplates the first group's use of a product made under the license. But the exhaustion doctrine's lifting of patent-law restrictions on a licensed product has never been applied to terminate patent rights in such complimentary activities or goods in these circumstances."

Importantly, the Federal Circuit suggested that to establish exhaustion, the Defendants would have had to tie their defense to particular claims:

"We do not foreclose an exhaustion defense that is tied to particular handset claims and targets particular content claims . . . . [that establishes] the presence of essentially the same inventive features in paired handset-content claims, as determined under a standard grounded in the statute, and the necessity that someone practice a handset claim for an asserted content claim to be practiced."

Because the Defendants did not present such a defense or bring any such evidence, their exhaustion defense was rejected.

Patent exhaustion is one of the most challenging issues in crafting or reviewing licensing arrangements. Careful review of patent exhaustion issues is necessary for both licensors and licensees. Please let us know if you have questions or if we can be of assistance.