On June 9, 2008, the United States Supreme Court issued its unanimous decision in Quanta Computer, Inc. v. LG Electronics, Inc. and held that the patent law cannot be used to control the subsequent use or disposition of a product "that substantially embodies a patent" once the product has been sold with authority of the patent owner.  "The authorized sale of an article that substantially embodies a patent exhausts the patent holder’s rights and prevents the patent holder from invoking the patent law to control postsale use of the article."  Moreover, patent exhaustion applies whether the patents are directed to products or to methods.  "Our precedents do not differentiate transactions involving embodiments of patented methods or processes from those involving patented apparatuses or materials."  In reaching its holdings, the Supreme Court reversed the Court of Appeals for the Federal Circuit which, in a line of cases, had steadily eroded the  patent exhaustion doctrine and had allowed patent owners to structure transactions providing post-sale patent restraint.

The Quanta case had engendered intense interest in the technology and licensing communities with over twenty amicus briefs filed.  Sheppard Mullin Richter & Hampton LLP had filed an amicus brief on behalf of the Licensing Executives Society urging the Court to clarify the exhaustion doctrine and its applicability in modern licensing transactions.  As is illustrated by the fact pattern in Quanta, exhaustion issues frequently arise where component parts are purchased from licensed sources and then assembled to form working products which allegedly infringe patents claiming the end product, rather than the component, per se.  This is a common occurrence in many industries including electronics, telecommunications, automotive, aerospace and the like.  Whether or not a patent owner is entitled to claim a royalty from the end product assembler, having already licensed the component manufacturer, is a multi-billion dollar question.

Quanta involved product and method patents owned by LG Electronics ("LGE") concerning microprocessor technology.  The claims of the LGE patents at issue were directed to microprocessors used in combination with semiconductor memory.  Intel had a cross-license with LGE under which Intel was authorized to "make, use, sell (directly or indirectly), offer to sell, import or otherwise dispose of" products practicing the LGE patents.  Intel sold microprocessors to Quanta.  Quanta then combined these microprocessors with semiconductor memory to form a working device which would have infringed the LGE patents.  It was undisputed that 1) the Intel microprocessors "constitute a material part of the patented invention and all but completely practice the patent," and 2) the Intel microprocessors "cannot function" unless connected to memory.

The Intel-LGE license included a provision stipulating that it did not grant a license "to any third party for the combination by a third party of Licensed Products of either party with items, components, or the like acquired … from sources other than a party hereto, or for the use, import, offer for sale or sale of such combination."   A separate Master Agreement between Intel and LGE required Intel to provide written notice to its customers that Intel’s license "does not extend, expressly or by implication, to any product that you make by combining an Intel product with any non-Intel product."  Intel provide such a written notice to Quanta.

LGE sued Quanta for patent infringement relying on the express restriction in the Intel-LGE license which withheld any license to Intel customers to combine Intel and non-Intel products.  The Federal Circuit found in LGE’s favor on grounds that 1) patent exhaustion did not apply to method patents 2) there could be no implied license to Quanta given the express language of the Intel-LGE license and the express notice provided to Quanta 3) the transaction was a restricted sale which did not trigger exhaustion because the license to Intel had a third party rights restriction and 4) the sale to Quanta was conditional because Intel had provided Quanta with express notice that it had no license to combine the Intel microprocessors with other products.

In reversing, the Supreme Court started with a review of its cases starting over 150 years ago which established the patent exhaustion doctrine.  "The longstanding doctrine of patent exhaustion provides that the initial authorized sale of a patented item terminates all patent rights in that item."  In particular, the Supreme Court found that its 1942 decision in United States v. Univis Lens Co., 316 U.S. 241 (1942) "governs this case."

Rejecting the argument that patent exhaustion did not apply to method patents, the Supreme Court explained that method patents were involved in Univis, as well as in the Ethyl Gasoline case, decided by the Supreme Court two years earlier.  Indeed, from a policy perspective "[e]liminating exhaustion for method patents would seriously undermine the exhaustion doctrine.  Patentees seeking to avoid patent exhaustion could simply draft their patent claims to describe a method rather than an apparatus."

Rejecting LGE’s reliance on the disclaimer of a license to third parties to combine licensed products with other components, the Supreme Court distinguished implied license from exhaustion and explained that whether customers received an implied license was irrelevant.  "But the question whether third parties received implied licenses is irrelevant because Quanta asserts its right to practice the patents based not on implied license but on exhaustion.  And exhaustion turns only on Intel’s own license to sell products practicing the LGE Patents."  The Supreme Court also rejected the assertion that because of the disclaimer, Intel’s sales were not authorized since despite the disclaimer "[n]othing in the License Agreement restricts Intel’s right to sell its microprocessors and chipsets to purchasers who intend to combine them with non-Intel parts."

Finally, rejecting arguments that the microprocessors could not exhaust because they do not embody all of the physical structure necessary to practice the claimed inventions and therefore were somehow different from the products in Univis, lens blanks which had to be ground into final form (without addition of further components), the Supreme Court held this distinction was immaterial.  What mattered was that the "incomplete article substantially embodies the patent because the only step necessary to practice the patent is the application of common processes or the addition of standard parts."

The Supreme Court’s Quanta decision represents the latest chapter in its recent acceptance for review and reversal of Federal Circuit decisions which had disregarded historical Supreme Court precedent and thereby enhanced patent owners’ rights and powers.  The Quanta decision will undoubtedly be the subject of careful study by patent and licensing practitioners who will probe its limits in an effort to devise new strategies for avoiding its effect.  Only time will tell whether such efforts will be successful.