If you weren’t exhausted before, you will be now

Impression Products, Inc. v. Lexmark, Intl., Inc., 137 S. Ct. 1523 (2017)

Some patent owners sell products in fields in which there is strong demand for used products or the servicing/repair of used products. Patent owners in these fields are vulnerable to competition from refurbishers who buy used items at deep discounts and then re-sell the refurbished goods more cheaply than the patent owner sells new products. The result is that refurbishers take market share away from the patent owner.

Patent exhaustion is one of the doctrines that enable refurbishers to compete with the patent owner in this way. Patent exhaustion allows used items to be re-sold, used down the chain of distribution, and repaired even if those items are patented. Patent owners, therefore, try to implement sales strategies that reduce the impact of patent exhaustion in order to preserve patent protections against refurbishers.

The patent owner in Impression tried to use sale restrictions to avoid patent exhaustion, but found that its sales restrictions were powerless to stop a savvy refurbisher. The Supreme Court made the exhaustion doctrine even more potent, ruling that sales restrictions imposed on customers do not thwart exhaustion. The Supreme Court rubbed even more salt in the wounds of patent owners, ruling that a sale anywhere in the world exhausts the U.S. patent rights for the item sold. Sales restrictions might not do the job, but license strategies remain available to avoid exhaustion, so long as courts in the future do not further expand the exhaustion doctrine to encompass even license transactions. Current law allows a patent holder to avoid exhaustion, and thereby exercise more downstream control over using, selling, offering to sell, and importing, when a patented item or method is supplied via license or lease instead of via a title transfer.

Some background is helpful to understand Impression better. Suppliers of patented goods can sue customers and other parties under not just patent infringement, but under many other theories as well These other theories might include breach of contract, unjust enrichment, unfair competition, antitrust, tort, and the like. Exhaustion knocks out patent infringement claims, but other claims under other theories remain.

This is important to appreciate, as the Impression decision expands the exhaustion doctrine but does not limit or restrict other claims. This appreciation is still problematic, because a patentee might not be in contract with or have other claims against third parties. Hence, exhausted patent rights remain a serious problem.

Under 35 USC 271, a patent holder has the right to stop another party from making, using, selling, offering to sell, or important a patented item or method. Exhaustion limits these rights. Once a patented item is sold, or its title is otherwise transferred by the patent holder or under the authority of the patent holder (such as by a licensee), the using, selling, offering to sell, and importing of the particular item sold are exhausted. This means that the patent holder cannot stop others from using, selling, offering to sell, or important the particular item that the patent holder placed into commerce.

Note that the making right generally is not exhausted. Purchasing a patented item does not generally give the acquirer any right to make further embodiments of that item. This implicates the repair v. reconstruction doctrine, where people can repair patented items freely (unless contractually restricted), but may not reconstruct them. Practically, reconstruction is tantamount to making a whole new patented item.

For exhaustion to apply, a key aspect is that an authorized sale or title transfer takes place. Up until the Impression decision, it also was the case that the authorized sale must have occurred under the U.S. patent at issue. Sale in a foreign territory did not trigger exhaustion. See Ninestar Technology Co. v. ITC, 667 F.3d 1373, 101 USPQ2d (Fed. Cir. 2012).

Impression was decided against this background. Lexmark the patent owner battled Impression the refurbisher. Lexmark sells ink cartridges for printers. Lexmark sells both in the US and internationally. Lexmark is vulnerable to refurbishers like Impression, because used ink cartridges can be re-filled, re-sold, and used again.

Lexmark implemented a sales strategy to protect itself from Impression and other refurbishers. Lexmark implemented a two-tier pricing strategy with post-sale restrictions. A customer can buy new Lexmark cartridges at a higher price ($$$$$$$) or at a lower price ($$$$). If the customer pays the higher price, the customer has no re-sale restrictions and is free to sell used up cartridges to refurbishers such as Impression. On the other hand, if the customer pays the lower price, the used cartridge must be returned to Lexmark. Lexmark implemented this strategy in its supply contracts around the world.

Unfortunately, in disregard of contract obligations, Lexmark customers would buy the Lexmark cartridges from Lexmark at the discount price. But rather than return the used up cartridges to Lexmark per the contract, the customers instead would sell the used cartridges to Impression. The thinking could have been, contract obligations aside, why return the used cartridges to Lexmark for free when Impression will pay for them?

Impression bought used Lexmark cartridges in the US and outside the US, refilled them, and then re-sold them for a discount much cheaper than the Lexmark pricing.

Lexmark sued Impression for patent infringement. Lexmark did not have a direct contract with Impression and, therefore, could not sue Impression for breach of the contractual post-sale restrictions in its customer contracts. Impression defended that the patent rights in the used cartridges were exhausted, allowing Impression to refurbish and re-sell without patent infringement.

Lexmark countered that exhaustion is not available as a defense to Impression. First, both the US and international cartridges were subject to post-sale restrictions. With those sales restrictions being violated, no authorized sale occurred that could trigger exhaustion. Further, acquisition of used cartridges outside the US cannot trigger exhaustion of U.S. patent rights per Federal Circuit case law.

Lexmark made solid arguments. This is shown by the fact that the Federal Circuit agreed with Lexmark and ordered Impression to pay patent infringement damages. The Federal Circuit agreed that lawful post-sale restrictions avoid exhaustion. Hence, Impression could not rely on patent exhaustion to negate Lexmark patent rights covering the used cartridges acquired by Impression. The Federal Circuit also reaffirmed that sales outside the US are unable to trigger exhaustion as a matter of law. Hence, to the extent Impression bought used cartridges outside the U.S., re-selling them in the U.S. would be infringement of the U.S. patent.

Impression appealed to the Supreme Court who agreed to decide (1) whether lawful post-sale restrictions avoid exhaustion; and (2) whether international sales exhaust US patent rights.

Impression, the refurbisher, won on both issues. The Supreme Court held that patent rights are exhausted even when the patented item is sold under lawful post-sale restrictions. The Supreme Court also held that an authorized sale of a patented item anywhere in the world exhausts US patent rights. Hence, Impression could rely on patent exhaustion to buy used cartridges from the Lexmark customers. Further, Impression could rely on patent exhaustion when buying used cartridges internationally and then re-selling them in the U.S.

The Supreme Court expressly noted that exhaustion only impacted patent infringement. Other causes of action, such as breach of contract, remained. It follows, therefore, that Lexmark could sue its customers for breach of contract, if Lexmark were of a mind to sue its customers. Of course Lexmark could not sue Impression for breach of contract, as Impression was not in contract with Lexmark. It also follows that Lexmark could have sued Lexmark under non-patent theories, to the extent any would have been available. The opinion does not show that Lexmark asserted any other causes of action against Impression, putting all of its eggs into the same patent infringement basket.

When the dust settles, Lexmark weakens patent rights in markets in which used products can be repaired and returned to service. Therefore, solid protection against refurbishers is needed in markets where new sales compete with used goods and repair/refurbishing services. One strategy is to stop exhaustion from happening so that patents can still be protected. Recall that under current case law, exhaustion is triggered by title transfer, not by license transfer. This suggests that products or services in these vulnerable markets should be transferred to customers by license or lease, not by sale or other title transfer, to leave patent rights available for protection.

Hence, license practice is implicated. In such instances, this would not be a classic license where the licensee is given a menu of making, using, selling, offering to sell, and/or importing rights. Rather, the item is already manufactured and in existence at the time supplied to the customer, but the transfer occurs via a license or lease, not a title transfer. This is analogous to leasing a car rather than buying it or leasing software rather than buying it.