LG Electronics versus Quanta: What Does it Mean for Manufacturers?

The Supreme Court held that 'conditional sales' may not be used to create post-sale restrictions.

On June 10, 2008, the U.S. Supreme Court ruled in the matter of LG Electronics, Inc. v. Quanta Computer Corporation, providing its first opinion on the issue of patent exhaustion in more than 65 years.

The doctrine of patent exhaustion provides that, under typical circumstances, an "authorized sale" of a patented product exhausts the patent monopoly as to that product. At issue in the Quanta case was whether a patent holder may reserve patent rights by making a "conditional sale" of the patented device, thereby limiting the manner in which a patented component may be used without potential liability for patent infringement. Confirming a line of cases beginning in the mid 1800s (addressing merchandise such as coffin lids, beds, and eyeglass lenses), the Supreme Court held that "conditional sales" may not be used to create post-sale restrictions.

This presents a number of issues for modern manufacturers, which often provide components that are used for different purposes by varying customers in disaggregated manufacturing chains. It is also important to manufacturers that own patents covering the both products they manufacture and their manner of use by downstream customers. To aid in understanding the import of the Quanta decision, following is an overview of both the Quanta case and specific examples of the issues presented to manufacturers.

LG Electronics ("LGE") owned two sets of related patents, one of which applied to microprocessor patents, while the other applied to use of those microprocessors in computer systems. Intel was licensed, without restriction or condition, to both the microprocessor patents (which Intel practiced) and the computer system patents (which Intel did not practice), although Intel paid a royalty based on the microprocessor patents alone. At the same time, LGE and Intel agreed that Intel would notify its customers that they needed a separate license from LGE to practice the computer system patents.

LGE sued Quanta for infringement (based on Quanta's use of Intel microprocessors in completed computer systems), and Quanta defended by arguing, inter alia, that Intel's sale of the microprocessor exhausted LGE's rights to the computer system patents. The Supreme Court ruled in favor of Quanta, holding that "[t]he 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."

The Supreme Court observed that Intel's sale of the article was "authorized," because Intel had unrestricted rights under both the microprocessor and computer system patents. The Court also noted that the microprocessor "substantially embodied" the claims of the computer system patents. Consequently, Intel's sale exhausted LGE's rights not only to the microprocessor patents, but also to the computer system patents later practiced by Quanta.

Giving effect to the "longstanding principle that, when a patented item is 'once lawfully made and sold, there is no restriction on [its] use to be implied for the benefit of the patentee,'" the Court concluded that Intel's notice to Quanta of reserved rights was ineffective to limit the patent exhaustion doctrine.

At the epicenter of this drama is the patentee manufacturer, because a patentee manufacturer may no longer use "conditional sales" to impose post-sale restrictions. A common post-sale restriction is the "field of use" limitation, which might arise when the patent has multiple potential uses (each with a different value), or where the patentee manufacturer attempts to reserve rights under related and co-owned patents.

If a patentee manufacturer has previously imposed post-sale restrictions, or required multi-level royalty payments for use of a patented component, that patentee must now reconsider its situation. First, it may attempt to impose similar restrictions through alternate means. One such alternate means, mentioned approvingly by the Supreme Court, is the conditional manufacturing license. Use of a conditional manufacturing license, however, may require that the patentee manufacturer restructure its business or subcontract certain aspects of its operations to a third party manufacturer. Given the tone and tenor of the Supreme Court's opinion, however, the patentee manufacturer must also consider whether and how it may obtain the full value for its intellectual property from its first customer.

Customers of patented articles should also consider whether the Quanta decision has relieved them of post-sale restrictions or multi-level royalty obligations. Restrictions might include "single use only" or "private use only." If imposed through use of a "conditional sale," those limitations may no longer be enforceable.

Although Quanta has broadened domestic application of patent exhaustion, it did not address the issue of international exhaustion. Under the Federal Circuit's decision in Jazz Photo Corp. v. Int'l Trade Commission, foreign sales (which do not otherwise involve an unconditional license under a U.S. patent) will not exhaust a U.S. patent holder's rights. So consider, what result if Intel had sold the microprocessors to Quanta outside of the United States? LGE may have successfully argued that the sales were not made under the "authority" of the United States patents, thereby avoiding patent exhaustion. Consequently, both patentee manufacturers and component customers must consider whether and how the venue and circumstances of the sale may avoid exhaustion of the U.S. patent rights.

While the Quanta decision is relevant to any person licensing or practicing patent rights, it is of marked importance to manufacturers, particularly manufacturers that hold patent rights to the device or components they manufacture.

Song K. Jung is a partner and Chair of the Intellectual Property and Technology practice for McKenna Long & Aldridge LLP in Washington, D.C. His practice focuses on all aspects of patent law, including patent prosecution, validity and infringement opinions, litigation, licensing, technology transfer and negotiation.

Adrian P.J. Mollo is a partner in the Intellectual Property Department of McKenna Long & Aldridge LLP in Washington, D.C. His practice focuses on patent licensing, strategic patent planning, intellectual property litigation, and intellectual property due diligence. http://www.mckennalong.com/

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