In Lexmark Decision, U.S. Supreme Court Upends Patent Rights Exhaustion and Licensing Strategies

The Supreme Court decided the case of Impression Products, Inc. v. Lexmark International, Inc. on May 30, 2017. Continuing its recent string of overturning Federal Circuit decisions, the High Court discarded rules that allowed restrictions on usage of patented items to be enforced even after an item is sold. Following its TC Heartland ruling in the same month, the May 30 decision sends another shot across the bow of patent owners and upends many long-held patent licensing strategies and product pricing policies.

Background

Lexmark International, Inc., designs, manufactures and sells printer toner cartridges to consumers in the United States and abroad. The company owns several patents that cover components of those cartridges and the way they are used. 

When Lexmark sells cartridges to consumers, it gives them two options: buy a toner cartridge at full price, with no restrictions, or buy a cartridge at a discount through Lexmark’s “Return Program.” In exchange for the lower price, customers who buy through the Return Program must sign a contract agreeing to use the cartridge only once and not transfer the cartridge to anyone but Lexmark. 

In the market, remanufacturers arose who acquired empty Lexmark toner cartridges from purchasers in the United States, refilled them with toner and then resold them. They do the same with Lexmark cartridges that they acquire from purchasers overseas and import into the United States. Impression Products, Inc., the defendant in the case decided by the Supreme Court, was just one of those remanufacturers. In addition to refilling Lexmark cartridges, Impression Products disabled a chip in the toner cartridges so that Lexmark printers could not detect that they were using unauthorized refills.

In response to this activity, Lexmark sued Impression Products for patent infringement.

Following a long trial and appeals history, the Supreme Court justices held that Lexmark’s suit could not proceed because once a patentee agrees to sell a product, “that sale exhausts its patent rights, regardless of any post-sale restrictions the patentee purports to impose.”

Patent Rights Exhaustion

The Supreme Court held that the Federal Circuit misapplied the doctrine of patent exhaustion, a defense to patent infringement which holds that patent owners lose their rights after an authorized sale, when the Federal Circuit previously decided that U.S. patent rights are not exhausted if a product is sold in another country and that patent owners can restrict how patented items can be used or sold following a sale.

The Supreme Court decided that selling a patented item exhausts all rights in the patent, regardless of where the sale takes place or any restrictions the patentee purports to impose. This decision will affect companies by requiring them to rewrite licenses that relied on post-sale restrictions. The decision could also lead them to charge higher prices to maximize revenue from the initial sale, especially given the application to international exhaustion.

Licensing Fallout

The Federal Circuit had long held that imposing limits on how patented items are used or sold could prevent patent exhaustion after a sale. Because of this, many companies included such restrictions in license agreements to hold on to their rights. Limits on what purchasers can do with patented goods have become widespread in the licensing context. The Supreme Court's holding that such restrictions exhaust patents will force those companies to re-evaluate these license agreements. 

At the same time, the ruling could seriously affect patent litigation that is currently ongoing by potentially allowing accused infringers to argue that they cannot be held liable for infringement because the patents are exhausted under theories that were not available prior to the Lexmark decision.

Product Pricing Fallout

Over time, under the Federal Circuit’s guidelines, patent owners adopted strategies to prevent patent exhaustion by setting the price of their products at a level that allowed them to generate revenue from multiple sales. After the Supreme Court's ruling, that option is no longer available and patent owners may respond by increasing prices to recoup what they consider “lost sales.”

Also, because the Supreme Court held that patent exhaustion is “uniform and automatic” upon the first authorized sale of an item, patentees will certainly need to adapt their licensing and sales strategies to focus their pricing policies for this first sale.

What About International Exhaustion?

Aligning its exhaustion jurisprudence with copyright law, the High Court held that the location of the first sale is irrelevant — international sales exhaust the patent rights, as well. Location arbitrage may be the logical result of this decision. Under the ruling, there is nothing in patent law to stop people from buying lower-cost products in foreign countries and shipping them to the United States to be resold at a price that undercuts the U.S. market. 

Companies may reconsider charging lower prices abroad, which is a common practice for many types of products. The High Court's decision that sales outside of the United States exhaust patent rights could upset pricing systems in which the same product is sold at different prices in different countries, often at lower prices in less wealthy parts of the world.

Strategies and Responses: Contracts

The High Court left the door open, via contract law, for sellers to enforce post-sale restrictions on how products are used once they are sold. If purchasers do not comply with the seller’s restrictions, “the only recourse” is through contract law, the High Court wrote. While this is a viable strategy, it can be a much more difficult path than patent litigation.

Contract law presents many hurdles for companies seeking to control the use of their products, as compared to a patent infringement suit. Contract claims must be brought in state court as opposed to federal court for a patent suit. The possible remedies fall short of what is available under patent law.

The target of the contract suit may also be problematic — in many cases, the contract is with consumers who purchase an item. Companies would face the unpalatable option of suing their own customers to enforce the contract, and doing so on a case-by-case basis, which would could also give rise to significant litigation costs.

While contract law may not be an appealing substitute for a patent suit in the case of inexpensive items sold directly to consumers, it could be more viable in other contexts, depending on the nature of the business. For example, when a company sells large or expensive items to other businesses rather than to individual consumers, there may be more flexibility and influence over the consumer through contract. 

Another option could involve restructuring agreements with those who sell their products so that a contract suit could be brought against retailers of the patented products. For example, the manufacturer could rewrite agreements to create a cause of action against the retailer if customers fail to abide by the restrictions the manufacturer wants to impose.

However, there are drawbacks and defenses in contract law not present in patent law. Contracts can be found unenforceable, against public policy or unconscionable in court, and as the Supreme Court held previously, a contract cannot be used to extend the life of a patent. Companies will need to weigh the options allowed them after Lexmark.

Strategies and Responses: Leasing

Another option to avoid the consequences of Lexmark would be to creatively restructure a company’s arrangement with consumers and stop selling things directly to avoid the first sale exhaustion. For example, many software companies use leases instead of sales.

Rethinking the contractual relationship with customers to circumvent an outright first sale could avoid the challenges of controlling the use of their products through contract law and enable manufacturers and others to continue to rely on patent law.

Conclusion

The fallout from the Lexmark case will continue as companies digest the ruling and evaluate how their patent licensing strategies need to evolve. Although new approaches and arrangements with customers may become available, the waters are murky and decisions can be complicated. Please contact a member of the Much Shelist Intellectual Property & Technology group if you have questions.

Jason Wejnert provides practical, creative legal guidance on a broad range of intellectual property matters to industry-leading clients—from small and mid-sized businesses to Fortune 500 companies. He focuses his practice on patent litigation for industry-leading clients, managing all aspects of patent litigation cases from inception through trial, as well as ex parte and inter partes reexamination and review proceedings.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.