Supreme Court Opinion in Quanta Computer, Inc. v. LG Electronics, Inc.

On June 9, 2008, the U.S. Supreme Court issued a unanimous decision in favor of Quanta in Quanta Computer, Inc. v. LG Electronics, Inc, 553 U.S. __ (2008). The Court reaffirmed the patent exhaustion doctrine and held that the authorized sale of a component -- at least where it substantially embodies a patent and has no uses but for practice of the patent -- exhausts the patentees' rights even as to finished products incorporating the component. In reversing the Court of Appeals for the Federal Circuit (“CAFC”), the Supreme Court identified three important issues and held: (1) the authorized sale of an item “substantially embodies” the invention triggers exhaustion; (2) method claims are subject to patent exhaustion; and (3) a sale by a licensee is “authorized” unless there are express limits to the licensee’s authority to make such sales. The Court’s decision in Quanta demands a strategic review of a patentees' licensing strategies and great care in drafting patent licenses that seek to avoid patent exhaustion.

In Quanta, LG had licensed its patent portfolio to Intel for the manufacture, use and sale of licensed microprocessors and chipsets. The license agreement disclaimed any license in favor of Intel’s customers that would allow them to combine Intel’s licensed products with non-Intel components. Intel also had separately agreed to provide written notice to its customers that they held no license to practice LG’s patents by combining the Intel chipsets with other components. Quanta practiced the patent by combining the chipsets with non-Intel components (bus and memory) necessary to make them operable and defended on ground that LG's patent rights were exhausted upon its agreement that Intel could sell the chipsets.

LG sued Quanta in the Northern District of California for infringement of claims covering computer systems which used the licensed chips and methods of operating the licensed chips. The district court held that the apparatus claims covering computer systems were exhausted by Intel’s authorized sale of the chips, but the method claims were not. The CAFC agreed that method claims were not subject to the patent exhaustion doctrine. However, the CAFC reversed the district court’s holding by reasoning that the license did not authorize Intel to sell chips to Quanta for use with non-Intel components.

In resolving LG's patent infringement claims, the Court applied United States v. Univis Lens Co., 316 U.S. 241 (1942) and held that the authorized sale of chipsets, because they constitute a “material part” of the patented invention or “substantially embody” the patented invention, exhausts the patents rights – even if the authorized product does not practice every claim limitation of the patent. The Court framed its ruling on this issue broadly, stating that the authorized sale of an incomplete article triggers exhaustion if all that is required to practice the patent is to add “non-inventive” elements or steps (i.e., “standard parts” or “common processes”).

The Court also rejected the idea that exhaustion could be avoided by asserting method rather than apparatus claims. The Court was concerned that clever draftsmanship would eliminate the patent exhaustion doctrine if method claims were exempt from exhaustion because most apparatus claims can be easily rewritten as method claims.

Perhaps most important looking forward, the Court analyzed whether LG had authorized Intel’s sale to Quanta. It relied on the fact that LG's license agreement broadly authorized Intel to make, use and sell its licensed chips. Because nothing limited Intel’s authority to sell its products, the Court reasoned, the patent was exhausted with respect to each of Intel's sales. Although Intel was required to notify its customers that they were not licensed to combine the Intel chipsets into a computer using non-Intel parts, this obligation was distinct from any lack of authority to make a sale. The Court thus left open the prospect that genuine restraints on a licensee's right to sell might avoid exhaustion.

While the Supreme Court appears to have called somewhat common licensing strategies into question, the Court’s holding is limited in application. Exhaustion still requires two elements: (1) an authorized sale of (2) an item embodying, or substantially embodying, the invention of the patent. The Court strongly implied that a licensee’s authority to make an “authorized sale” could be limited so as to preclude exhaustion with careful drafting of license agreements. The Court also expressly reserved the question of whether existing contract rights under patent licenses might survive the exhaustion of patent rights. This may provide some refuge to patentees whose licensing strategies have been called into question by the decision.