Expectations For High Court Patent Exhaustion Decision

March 23, 2017

Ethan W. Marks, Charles T. Steenburg

(as published in Law360)

The U.S. Supreme Court’s upcoming decision in Impression Products Inc. v. Lexmark International Inc. will address two patent exhaustion issues, both of which have sparked significant concern about the potential consequences if the court alters current law.

Specifically, the Federal Circuit has held that (1) selling a product outside the United States does not exhaust U.S. patent rights, and (2) patent owners can avoid patent exhaustion by imposing restrictions (e.g., a single-use limitation or a prohibition on resale) at the time of sale.[1] This discussion focuses on the latter issue given the widespread belief that the Supreme Court is likely to hold that patent owners cannot use patent law to enforce restrictions following the initial sale. The U.S. government has urged the court to adopt such a rule and reverse the Federal Circuit’s 1992 holding in Mallinckrodt v. Medipart.[2] Moreover, ever since the Supreme Court’s 2008 decision in Quanta Computer v. LG Electronics,[3] a number of commentators and district court judges have suggested that Quanta silently overturned Mallinckrodt.

Lexmark and various amicus briefs raise a number of concerns about the “mandatory exhaustion” scheme proposed by Impression and the government. In particular, they complain that overturning Mallinckrodt would, inter alia, (1) increase prices for consumers, (2) hike supply costs — deterring certain economically desirable activities altogether, (3) endanger public health (e.g., if a medical device intended for a single use is reused), and (4) negatively impact goodwill (e.g., if a “remanufactured” printer cartridge does not perform properly and degrades Lexmark’s reputation for reliability).

Further, Lexmark maintains that contractual remedies are inadequate to prevent these problems — a point that counsel reiterated during oral argument this week.

A Supreme Court decision overruling Mallinckrodt plainly would have consequences. However, there is reason to believe that the concerns raised by Lexmark and the amicus briefs may be somewhat overblown. The briefing and arguments were long on policy, but short on concrete examples of post-Quanta cases that actually turned on a patent owner’s argument that a sale had been “conditional” or “restricted” to avoid exhaustion. Indeed, Mallinckrodt itself may be a much more limited holding than its proponents believe, particularly given the difficulty in establishing that buyers actually agreed to the alleged conditions or restrictions. Further, in cases where a patentee can establish an enforceable restriction, breach of contract and related state-law theories may be more potent alternatives to patent infringement claims than detractors believe.

Lexmark’s Business Model and Impression’s Stipulation

The facts of the case merit particular attention, as Lexmark went to significant lengths to ensure the existence of a valid contract in the first place.

Lexmark sells printers along with two types of replacement toner cartridges: "regular cartridges" and "return program cartridges." Lexmark sold regular cartridges without restricting how buyers could use or resell the products. It also sold return program cartridges at a significant discount (approximately 20 percent) and subject to an express single-use/no-resale restriction. Customers who purchased return program cartridges were not permitted to refill them or transfer empty units to anyone other than Lexmark.   

Nevertheless, Impression Products Inc obtained spent return program cartridges and then cleaned, refilled, and resold the cartridges in the United States.

Lexmark sued Impression for patent infringement. Ultimately, Impression acknowledged that Lexmark’s patents were valid and covered the accused cartridges. Impression also stipulated that the original purchasers of the return program cartridges had entered into a valid contract with Lexmark and agreed not to reuse or resell the products. Indeed, other courts had previously held that Lexmark had enforceable agreements. These earlier decisions emphasized that customers received consideration in the form of the discount.[4]

Despite Impression’s stipulation, the district court dismissed Lexmark’s infringement claims on the ground that Lexmark had exhausted its patent rights given the initial sale. Specifically, the court agreed with Impression that Quanta had silently overruled Mallinckrodt, such that single-use restrictions were not enforceable under patent law against downstream users.

Sitting en banc, the Federal Circuit reversed the district court and reaffirmed the principles of Mallinckrodt. Ten of the 12 judges joined the majority decision and distinguished Quanta as involving a contract that had conveyed unrestricted authority to sell.

During oral argument on March 21, Lexmark defended the Federal Circuit’s analysis and maintained that contract-based remedies were unavailing because Lexmark was not in privity with Impression, which instead had obtained the return program cartridges from Lexmark customers or a fourth-party recycler. Further, Lexmark emphasized that “suing our individual customers” would be “bad business.”

Other Cases Addressing Alleged Conditional Sale Theories Under Patent Law

In the nine years since Quanta, numerous decisions have cited Mallinckrodt and subsequent Federal Circuit cases such as B. Braun Medical, which reiterated that exhaustion “does not apply to an expressly conditional sale or license.”[5]

Setting aside Lexmark and its discount program, however, it is difficult to pinpoint any patent owners that actually overcame exhaustion theories on this basis following Quanta. Indeed, to the extent that other patentees prevailed in post-2008 cases, the facts are typically quite different and involve the reproduction of products (e.g., successive generations of genetically modified seeds).[6] The Supreme Court’s 2013 Bowman v. Monsanto decision should offer some comfort for patent owners in such circumstances regardless of how Lexmark fares.[7]

On the other hand, the Federal Circuit has repeatedly held that alleged conditional sales were actually unrestricted — and thus exhausting — because the purported limitations (e.g., a single-use restriction or a requirement to use disposable supplies from a particular manufacturer) were not part of an enforceable contract. Instead, the ostensible restrictions — appearing on stickers or product packaging — did not reflect any meeting of the minds between buyer and seller.[8] Unlike Lexmark and its discount structure, the patent owners in those cases could not cite anything of value that purchasers had obtained in exchange for the alleged restrictions.

Even Mallinckrodt noted that the district court had never actually decided whether the “single use only” notice was legally sufficient as a condition. Instead, the lower court had concluded that such restrictions could not be imposed under patent law, “whether or not … enforceable under some other law.”[9] The Federal Circuit vacated and remanded without addressing this threshold question, and the case settled shortly thereafter.

Different Implications for Different Types of Patent Owners?

Given the challenges of establishing a conditional sale even under current law, the impact of a decision reversing Mallinckrodt and announcing a “mandatory exhaustion” rule may vary significantly depending on whether (1) a patentee is selling directly to end users, or instead negotiating more sophisticated contracts (e.g., individualized supply or distribution agreements), and (2) in the case of patentees selling to end users, whether the patentee has adopted an approach like Lexmark’s discount structure or otherwise genuinely strived to establish an enforceable contract.

Category 1: Sophisticated Supply or Distribution Arrangements

Lexmark and various amici stressed the problems that a mandatory exhaustion rule could pose for patent owners that sell products with two or more applications, each having different economic value. During oral argument, for example, attention focused on hypothetical chips that could be used in a camera but added more value when used in a computer. Overruling Mallinckrodt could deter patent owners from ever selling chips to camera manufacturers unless they agreed to pay the higher prices associated with the computer market. Selling to camera manufacturers at a lower price could lead to arbitrage, without fear of liability for patent infringement.

However, given the nature of such transactions, it typically should be possible to structure agreements such that resale into a different channel would clearly constitute a breach of an enforceable contract — with the offender in privity with the patent owner. In such cases, the impact of overruling Mallinckrodt would depend on how one weighs the advantages of a patent claim against a contract claim. A full treatment of this question is beyond the scope of this article. That said, some of the most common complaints raised in amicus briefs — lack of injunctive relief or potential entitlement to attorneys' fees, for example — do not necessarily hold water. In one case, for example, a trial court granted a preliminary injunction based on a breach of contract theory despite citing exhaustion as the basis for rejecting the plaintiff’s patent infringement theory.[10] Further, contracts can provide for the prevailing party to obtain attorneys' fees as a matter of course.

Category 2: Garden Variety Sales to End Users

Given the Federal Circuit’s refusals to enforce ostensible restrictions on stickers, packaging or package inserts, there is reason to doubt whether reversing Mallinckrodt would significantly harm typical patent owners making standard sales to consumers or other end users. Such sales are unlikely to be deemed “conditional” even under current law.

Category 3: Creative Arrangements Such as Lexmark’s Approach

Reversing Mallinckrodt presumably would be a significant blow for Lexmark itself, which has pursued the differential pricing strategy for years and had reason to believe that the one-time use restriction associated with return program cartridges is enforceable, as Impression stipulated and previous courts have held. Likewise, one cannot fault Lexmark for declining to sue individual customers. That said, Lexmark conceivably could pursue tortious interference claims against companies that collect spent cartridges from those customers. Lexmark actually did pursue such a theory in a previous case, but dropped it shortly before trial for reasons that are not clear, but may have involved discovery-related disputes.[11]

The bigger question is how many other patent owners have pursued business models comparable to Lexmark’s extensive efforts to impose post-sale restrictions on patented articles sold to consumers or other end users, particularly after Quanta. The lack of concrete examples (i.e., efforts going beyond stickers, package inserts, or other language that the Federal Circuit is likely to deem unenforceable) in the amicus briefing and previous reported cases is notable, albeit not dispositive. The authors submit that efforts as involved as Lexmark’s campaign are likely unusual, although not unique.

Caveat: Blurry Lines? 

This is not to suggest that every patentee will fit neatly in one of the above categories. For example, certain medical device manufacturers may arrange contracts with doctors to include one-time use restrictions that are technically enforceable as a matter of contract law (e.g., if proposed in exchange for a discounted purchase price), but realistically speaking impossible to enforce against the doctors themselves. Instead, the manufacturers may count on the ability to sue reprocessors downstream. Here again, however, the apparent dearth of concrete examples in post-Quanta case law and the Lexmark amicus briefing merits consideration.

Conclusion

Reversing Mallinckrodt would have consequences. That said, it is far from clear that it would have the profound impact that some have suggested.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.


[1] 816 F.3d 721 (Fed. Cir. 2016) (en banc). Subsequent references to the facts of the case refer to this decision.

[2] 976 F.2d 700 (Fed. Cir. 1992).

[3] 553 U.S. 617 (2008).

[4] E.g., Arizona Cartridge Remanufacturers Ass’n v. Lexmark Int’l, 421 F.3d 981, 987 (9th Cir. 2005).

[5] 124 F.3d 1419, 1426 (Fed. Cir. 1997).

[6] E.g., Monsanto v. Bowman, 657 F.3d 1341, 1346–48 (Fed. Cir. 2011); PSN Illinois v. Abbott Labs., No. 09 C 5879, 2011 WL 4442825, at *11 (N.D. Ill. Sept. 20, 2011) (“[T]he manufacture of an additional S1P2 technologies is an independent act of infringement not exhausted by an initial authorized purchase.”).

[7] 133 S. Ct. 1761 (2013). Granted, the Supreme Court stressed that its holding did not necessarily extend to all products merely because they happen to be “self-replicating.”

[8] LifeScan Scotland v. Shasta Techs., 734 F.3d 1361, 1375 n.8 (Fed. Cir. 2013) (sticker); Jazz Photo Corp. v. ITC, 264 F.3d 1094, 1108 (Fed. Cir. 2001) (package instructions); Hewlett-Packard Co. v. Repeat-O-Type Stencil Mfg., 123 F.3d 1445, 1453-54 (Fed. Cir. 1997) (package insert).

[9] 976 F.2d at 701.

[10] O.D.F. Optronics Ltd. v. Remington Arms Co., No. 08 CIV. 4746 (DLC), 2008 WL 4410130, at *13 (S.D.N.Y. Sept. 26, 2008).

[11] See Static Control Components, Inc. v. Lexmark Int’l, Inc., Civil Action Nos. 5:02–571, 5:04–84 (E.D. Ky.). Separately, the court held that Quanta overruled Mallinckrodt, precluding Lexmark’s patent claims. 615 F. Supp. 2d 575, 588 (E.D. Ky. 2009) (granting motion for reconsideration and vacating pre-Quanta decision).