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Article discusses recent review of the issue of patent exhaustion, and what overturning those rules would mean to patent enforcement

April 21, 2015

Fed. Circ. Could Weaken Patent Rights In Exhaustion Case
By Ryan Davis

Law360, New York (April 21, 2015, 9:35 PM ET) -- Longtime Federal Circuit precedent allowing patent owners to control the use of their products after they are sold is in question since the full court has decided to review the issue of patent exhaustion, and attorneys say overturning those rules would create significant new hurdles to patent enforcement.

The Federal Circuit decided last week on its own motion to conduct an en banc review in Lexmark International Inc.'s infringement suit against a printer cartridge reseller to address whether two of the court's precedents on patent exhaustion remain good law in light of recent U.S. Supreme Court rulings.

The case involves two separate questions. In the first one, the Federal Circuit will decide whether the sale of a patented item outside the U.S. exhausts the patent owner's rights to later sue for infringement.

While the Federal Circuit held in a 2001 case known as Jazz Photo that only sales within the U.S. exhaust patent rights, the high court ruled in a 2013 case known as Kirtsaeng that foreign sales exhaust rights under copyright law. The Federal Circuit will decide whether the Supreme Court's copyright decision applies to patent law.

The second question is whether patent owners can impose restrictions on the use of patented items after they are sold in order to keep the sale from exhausting their rights. The Federal Circuit said in a 1992 decision known as Mallinckrodt that such restrictions are enforceable, but the Supreme Court said in a 2008 ruling known as Quanta that authorized sales exhaust patent rights.

Many patent owners rely on the Jazz Photo and Mallinckrodt rulings to retain control of patented items and file infringement suits even after the items have been sold once, so if the Federal Circuit were to overrule either or both of those precedents, it could dramatically reshape patent enforcement strategies, attorneys say.

Joseph Re of Knobbe Martens Olson & Bear LLP said that on both questions, the issue amounts to: Can you still have strings attached after you have a lawful sale?

"It's a tough question and there are no clear answers," he said. "But the fact that the Federal Circuit is re-evaluating this is obviously not a good sign for patent owners."

The Federal Circuit's ruling on both questions have wide-ranging implications for patent enforcement, said Matthew Cutler of Harness Dickey & Pierce PLC.

"This really is about the scope of patent rights and how far you can extend the patent monopoly," he said.

Printer cartridge maker Lexmark accuses Impression Products Inc., which refurbishes and refills Lexmark cartridges and resells them, of patent infringement. Impression argues that Lexmark's patent rights are exhausted under two different theories.

With regard to cartridges Lexmark first sold outside the U.S., Impression argues that the initial overseas sale exhausted the company's rights. It claims that the Kirtsaeng decision in copyright law applies equally to patent law and implicitly overruled the holding in Jazz Photo that only U.S. sales exhaust patent rights.

Impression's exhaustion argument with regard to Lexmark cartridges first sold within the U.S. hinges on a discount program that Lexmark runs, where it sells some cartridges at a lower price if the buyer agrees to use them only once and then return them. Higher-priced Lexmark cartridges have no restrictions on their use.

Impression argues that Lexmark's sales of the lower-priced cartridges exhausted its rights and that the decision in Quanta that authorized sales exhaust patent rights means the single-use restriction cannot preserve Lexmark's rights after a sale.

The district court ruled differently on each issue last year. It held that because copyright law and patent law are different, the Kirtsaeng decision does not overrule Jazz Photo, and Lexmark's overseas sales did not exhaust its rights.

However, the district court agreed with Impression that under Quanta, Lexmark's rights on the cartridges sold in the U.S. were exhausted by the first sale, despite the single-use restriction.

Now it is up to the full Federal Circuit to sort out both questions, each of which involve different complex issues. In addition to printer cartridges, patent exhaustion is used as a defense in infringement cases involving products that can be reused and resold, including razor blades, syringes and seeds.

If the Federal Circuit were to hold that initial sales outside of the U.S. exhaust patent rights, it could create a new industry of companies buying patented products overseas, where they are sold at a lower price, then importing the items into the U.S. and reselling them for a higher price at a profit.

"Any industry where you have a price differential geographically that can justify a third party buying products abroad and importing them into the U.S. will potentially be affected by this decision," said Derek Dahlgren of Rothwell Figg Ernst & Manbeck PC.

Since Jazz Photo remains controlling precedent in patent law, it is now presumably illegal to refurbish items purchased overseas and resell them in the U.S., but the Federal Circuit could effectively give its blessing to such a business.

"If it is found that Jazz Photo is no longer good law, it would really open up that market," said Justin Daniels of Proskauer Rose LLP.

It is far from certain that a copyright ruling like Kirtsaeng is applicable to patent law, attorneys say. For one thing, the Supreme Court's decision was based on an interpretation of the Copyright Act, while patent exhaustion is judge-made law not based on any statute.

"What the Federal Circuit has to decide is: Did the Supreme Court in Kirtsaeng silently overrule decades of cases from the Federal Circuit saying that the mere fact that a product is sold abroad doesn't exhaust patent rights?" said David Leichtman of Robins Kaplan LLP.

Re noted that there are major differences between copyright law and patent law, including that importing an item purchased abroad is a distinct act of infringement in patent law, but not copyright law. That suggests a foreign sale should not curtail a patent owner's ability to control importation, he said.

Past Supreme Court rulings have indicated that patent law does not extend to foreign activities, so if the Federal Circuit goes the other way, "the practical consequences could be dramatic," said Alicia Carney of Fisch Sigler LLP.

"Kirtsaeng weakened the territorial requirement of patent exhaustion," she said. "But there remains the strong presumption that U.S. patents end at U.S. borders."

The issue of single-use restrictions is less clear-cut and may turn on the specific facts surrounding Lexmark's restrictions compared to those at issue in Mallinckrodt and Quanta. It is possible the court could rule on whether Lexmark's restrictions exhausted its rights without making a broader ruling about what kinds of restrictions are permissible.

Still, any Federal Circuit ruling on the issue would be influential, Cutler said.

"There are a significant number of companies and industries that make use of restricted-use type sales as a way to extend patent coverage beyond the first sale," he said, so a ruling that patent rights are exhausted despite such restrictions would be "a huge seismic shift in many industries."

If patent owners could no longer rely on patent infringement suits to enforce single-use restrictions, they would be forced to file breach of contract suits when someone violates them, which is a less effective alternative, Re said.

"Patent law would prevent the use of the patented article no matter who is the user," he said. "The contract is only between the parties to the contract."

However the court rules, the Federal Circuit can provide useful guidance that may put to rest long-simmering disputes about the impact of the Kirtsaeng and Quanta rulings, provided the decision isn't appealed to the Supreme Court.

"It's a good sign for patent law when the Federal Circuit does this, rather than leave these areas vague and create uncertainty," Daniels said. "Having certainty is one of the most important things for companies. At least you know where you stand and can assess the risk."

Editing by Katherine Rautenberg and Kelly Duncan.