Diagnosis: P.E.D.

Quanta Computer, Inc. v. LG Electronics, Inc.

Life's a little less good for patent holder LG Electronics ("LGE") since the Supreme Court determined in Quanta Computer, Inc. v. LG Electronics, Inc. that P.E.D - the patent exhaustion doctrine - terminally infected its patent infringement claims. The doctrine provides that a patent holder can only obtain one recovery for an infringement. Once that recovery has been made-by way of a judgment or a license-further enforcement is exhausted.  Exhaustion has particular application in circumstances where the patent holder licenses the supplier of a component, but then later seeks to enforce its patent against that supplier's downstream customers.

In LGE/Quanta, the patents at issue covered technology associated with the way microprocessors and other devices access memory over a data bus.  LGE had licensed its portfolio to Intel, authorizing Intel to make, use, or sell its products practicing the LGE patents without limitation.  Notwithstanding this broad language, LGE did not intend that the license apply to Intel's customers; other sections of the license agreement stated that LGE did not grant a license to third parties to combine Intel's products with other items or components to build a larger system.  Intel also agreed to give written notice to its customers informing them that the license did not extend to combinations of an Intel microprocessor with non-Intel products.

LGE sought to enforce its patents against Quanta Computer, who had obtained Intel microprocessors and combined them with non-Intel components to build a complete computer system that practiced the LGE patents.  Quanta asserted the protections of the patent exhaustion doctrine.  In essentially adopting Quanta's position, the Supreme Court made three rulings.  First, primarily to prevent mischief with regard to innocent purchasers, it determined that patent exhaustion applied to method claims as well as apparatus claims.

Next, it held that the license of a component part that does not fully practice a patent can still lead to patent exhaustion when the licensed component part "substantially embodies" the broader patent. The Court determined that LGE's license of the component created exhaustion because "the only reasonable and intended use" of the microprocessor was to practice the patent and because it "embodied essential features of the patented invention."

Finally, the Court found exhaustion applied even to those situations where the parties attempted to inoculate against the doctrine by indicating within its license agreement the desire not to exhaust the patents.  The Court explained that the primary question was a licensee's authority to sell products embodying the patent-and found no meaningful limitation in the actual grant to Intel; the contrary language in other parts of LGE's licensing agreement was directed to the conduct of third parties.

Patent holders are wondering just how contagious LGE/Quanta will be.  The decision provides ample ammunition for defendants in situations where their component suppliers have some form of license.  No doubt such downstream defenders will be putting their agreements under the microscope to check for any relevant limitations. 

Certainly patent holders will want to try to immunize their licenses by carefully crafting the authorization language in the section granting the license.  The Court suggests that a different result may have occurred had those conditions and limitations expressly limited the grant of the license.  Licensors should dispense with strategies based upon intent and focus upon the need to clearly delineate limitations on the grant of authority.  Alternatively, patent holders could shift their enforcement efforts to customers and end users, rather than component suppliers.

We predict that litigation regarding the circumstances under which an unpatented component may fairly be viewed as "substantially embodying" a broader invention will become chronic.  Litigants on both sides will have to look for opportunities to build a record which either marginalizes or trumpets the importance of the unpatented component.  Note that the Court chastised LGE for not demonstrating that the microprocessors at issue could be used in a non-infringing way, but offered little in the way of bright line tests for determining when an unpatented component substantially embodies a patent.

Finally, litigants will have to be alert for the availability of breach of contract claims.  The Court expressly stated that its decision did not limit LGE's contract rights, if any.  In its ever increasing efforts to stem patent litigation, the Court may have shifted the same technologic dispute into a different substantive legal arena.   We don't see how an epidemic like that will leave anyone-patent holder or potential infringer-feeling that life's good.

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