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Legal Affairs : Aug 1, 2008 (Vol. 28, No. 14)

Enforceability of Patent Licenses Under Fire

Supreme Court Ruling in Quanta Has Implications for Biotechnology Industry
  • Courtenay C. Brinckerhoff

The Supreme Court’s recent decision in Quanta Computer v. LG Electronics (LGE) is important for biotechnology companies even though the patents at issue relate to computer systems. The Court addressed the patent exhaustion doctrine and made two main holdings: (i) method patents are subject to exhaustion and (ii) authorized sales of products that substantially embody a patent exhaust the patent.

The Court further explained that a product that does not by itself completely practice a patent but whose only and intended use is to practice the patent can trigger exhaustion if it embodies the inventive features of the patent. Because exhaustion eliminates a patent holder’s right to control post-sale use, Quanta’s broad view of the doctrine may impact the enforceability of existing patent licenses and should inform how new biotechnology licenses are crafted.

The dispute between LGE and Quanta involved LGE’s patents to methods performed by components of computer systems. LGE licensed the patents to Intel under terms that permitted Intel to manufacture and sell computer components and systems that use the patents. Quanta purchased licensed Intel components from Intel and following Intel’s specifications, manufactured computers that combined the licensed Intel components with non-Intel components in a manner that practiced the LGE patents.

The LGE-Intel license agreement included several terms important to the Court’s decision. The license authorized Intel to “make, use, sell (directly or indirectly), offer to sell, import, or otherwise dispose of” Intel components practicing the LGE patents. The license also stipulated that no license “is granted...to any third party for the combination by a third party of Licensed Products...with items, components, or the like acquired...from sources other than [Intel or LGE].”

On the other hand, the license stated that the usual rules of patent exhaustion apply, providing that “notwithstanding anything to the contrary contained in this Agreement, the parties agree that nothing herein shall in any way limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products.”

The parties also entered into a “Master Agreement” that provided that Intel would give written notice to its customers that while it had a license “ensuring that any Intel product that you purchase is licensed by LGE and thus does not infringe any patent held by LGE,” the license “does not extend expressly or by implication to any product that you make by combining an Intel product with any non-Intel product.” The Master Agreement also stated that “a breach of this Agreement shall have no effect on and shall not be grounds for termination of the Patent License.”

LGE charged Quanta with patent infringement, asserting that Quanta’s combination of licensed Intel components with non-Intel components was not authorized by the LGE-Intel license and so infringed LGE’s patents.

The district court initially granted summary judgment for Quanta, invoking the doctrine of patent exhaustion, but then limited its summary judgment ruling to the product claims of the LGE patents on the ground that the doctrine does not apply to method claims. The Federal Circuit affirmed-in-part and reversed-in-part, agreeing that the doctrine does not apply to method claims and also finding that the doctrine did not apply because LGE did not authorize Intel to sell components for use in combination with non-Intel components. The Supreme Court disagreed with both the Federal Circuit’s conclusions.

The doctrine of patent exhaustion “provides that the initial authorized sale of a patented item terminates all patent rights to that item”—the patent holder has reaped the benefits of the sale, and the patent rights are exhausted. The Supreme Court found the Federal Circuit’s distinction between product claims and method claims to be unjustifiable, providing an easy “end-run around exhaustion.” The Court, therefore, held that method claims are subject to exhaustion.

Because the licensed Intel components could not by themselves practice the methods of the LGE patents, the Court had to decide “the extent to which a product must embody a patent in order to trigger exhaustion.” The Court followed its own precedent holding that exhaustion arises from the authorized sale of a product that “sufficiently embodies the patent” such that it is “capable of use only in practicing the patent.”

The Court found that “the only step necessary to practice the [LGE] patent is the application of common processes or the addition of standard parts” to the licensed Intel components and that “everything inventive about each patent is embodied” in the licensed Intel components.

The Court also noted that “Quanta was not required to make any creative or inventive decision when it added [the non-Intel] parts.” The Court concluded that the licensed Intel components embodied “the essential features of the LGE patents because they carry out all the inventive processes when combined, according to their design, with standard components.”

The Court then considered whether Intel’s sale of components to Quanta was authorized under the LGE-Intel license agreement. LGE argued that the sale was not authorized because the license did “not permit Intel to sell its products for use in combination with non-Intel products to practice the LGE patents.”

The Court rejected that argument, however, noting that nothing in the license restricted “Intel’s right to sell its components.” The Court determined that neither the clause denying the creation of any third-party licenses nor the notice requirement of the Master Agreement limited Intel’s “broad right” to “make, use, [or] sell” its products.

The Court concluded that the license “authorized Intel to sell products that practiced the LGE patents,” and “no conditions limited Intel’s authority to sell [such] products.” Those findings meant that Intel’s sale to Quanta was “authorized,” and that patent exhaustion prevented LGE’s infringement claim against Quanta.

The Court left open the possibility that LGE might have a breach of contract claim against Quanta, but held that once there has been an authorized sale of “an article that substantially embodies a patent,” patent laws cannot be used “to control post-sale use of the article.”

Patent Restrictions

The Quanta decision may impact biotechnology licenses in several respects. Biotechnology patent licenses often contain use restrictions such as licenses for a specified field of use or for noncommercial research purposes.

Quanta does not negate the validity of such restrictions but indicates that they should be plainly and expressly set forth in license agreements.

If a licensor wants to restrict downstream uses of licensed technology, Quanta supports the use of direct limitations in license grant clauses over clauses that deny third-parties licenses. For example, the license could grant the right to make and use the invention for noncommercial research purposes with no right to sell products embodying the invention instead of merely stating that the license does not give third parties a right to use the invention.

If a biotechnology company has patents covering several different methods of using a product, Quanta should not prevent licensing the methods separately but care should be taken so that an authorized sale of a product does not exhaust other patent rights. For example, the license could permit the sale of licensed products only for the use in the licensed method such as for use in diagnostics but not therapeutics.

Where practical, the license also could restrict the definition of licensed products so that they would not “substantially embody” an unlicensed method. For example, if the unlicensed method involves the use of a specific promoter, licensed products could be defined to exclude products incorporating that promoter.

Inventions surrounding products that can replicate themselves, such as genetically engineered plants, present additional issues under the exhaustion doctrine. It is common industry practice to sell patent-protected genetically engineered seeds with bag-tag restrictions providing that the purchased seeds may be used to grow a crop for sale as harvested material but may not be used for the production of seeds for a second-generation crop.

Moreover, there is an understanding supported by Federal Circuit precedent that the authorized sale of a product that is capable of replicating itself does not exhaust the patent vis-à-vis next-generation products.

While Quanta calls into question some of the underpinnings of the relevant Federal Circuit decisions, it is not likely that Quanta will be applied to vitiate this basic principal. Quanta turns on the authorized sale of licensed products, while the unauthorized replication of a licensed product does not involve a sale of next-generation products.

Additionally, the licensed products typically are sold for a different primary use (e.g., to grow a single commercial crop), such that replication would not be their only intended use.

Thus, a court applying Quanta is likely to uphold terms that restrict replication and find that the patents are enforceable against those who make, use, or sell unauthorized next-generation products even if generated from authorized first-generation products.

Quanta’s final lesson for biotechnology patent holders is that the patent laws may not be the only remedy for unauthorized uses of patented technology. While not directly addressing the issue, Quanta reminds us that breach of contract claims may provide alternative remedies when patent rights are exhausted.

Courtenay C. Brinckerhoff is a partner at Foley & Lardner. Web: www.foley.com. Email: cbrinckerhoff@ foley.com.