US Supreme Court rewrites the rules on patent exhaustion

August 2017

By Emma Barraclough, Freelance journalist

“When you’re RIGHT, you FIGHT,” reads the website tagline of Impression Products Inc. But the decision by the small family-owned business to fight a patent lawsuit over printer ink cartridges has had an impact far bigger than the company would ever have imagined: the rules on patent exhaustion in the United States have been rewritten, upending the business practices of companies in the repair and spare parts sector and potentially forcing US patent owners to rethink the way that they price their products around the globe.

A small company in West Virginia built a business on selling refilled
printer cartridges. When it was accused of infringing patents, it decided
to fight. Its victory at the Supreme Court has reshaped the doctrine
of exhaustion and forced businesses to review their business
strategies (photo: iStock.com/© sergeevspb).

The dispute involved two companies: Lexmark, a Kentucky-based multinational business that makes and sells imaging equipment; and Impression Products, a West Virginia company whose 25 employees repair printers and resell printer cartridges.

For decades the printer ink industry has sought to defend its lucrative after-sales ink cartridge market, developing a range of technological and commercial barriers to deter competitors from refilling and reselling printer inks. Lexmark utilized both high-tech solutions and financial incentives. It offered customers two pricing options: a full-price ink cartridge that users could dispose of as they wish and a lower-priced version sold through the company’s “Return Program”. These cartridges were fitted with a microchip to prevent reuse, and customers agreed to transfer their empties only to Lexmark.

The legal battle between the two began when Lexmark formally objected to Impression’s business practices: buying up empty Return Program printer cartridges, filling them with new ink, removing their microchip and selling them on.

As the case wound its way through the US courts, judges were asked to consider two questions: had Impression infringed Lexmark’s patents by selling refilled Return Program cartridges in the United States when Lexmark had specifically barred reuse and resale, and had it breached Lexmark’s patent rights by importing printer cartridges into the United States that the company had sold overseas?

At the heart of the questions is the exhaustion doctrine.

The doctrine of patent exhaustion holds that once a patent owner has sold a patented product for the first time, they no longer have control over it: the buyer can use, sell, license, or destroy it as they wish. The Lexmark dispute raised questions about the extent to which a patentee can impose restrictions on what a buyer does with a product once they have bought it and enforce those restrictions under patent law. It also sought clarification about the application of the doctrine of exhaustion to goods sold overseas, where US patent law does not apply, which are then imported for sale in the United States.

The Federal Circuit decision

The importance of the issues raised by the case led Federal Circuit judges to decide to hear it en banc, citing the need to consider whether its earlier decisions on questions related to patent exhaustion remained sound in the light of subsequent rulings by the Supreme Court, including the Kirtsaeng copyright case (see box).

Photo: iStock.com/© alexis84

In February 2016 a majority of Federal Circuit judges backed Lexmark, concluding that the company’s patent rights had not been exhausted by its first sale. The Court held that Lexmark was within its rights to sue Impression for patent infringement on the grounds that a patent owner who sells an item with clear limits on resale or reuse can enforce those restrictions with a patent infringement claim.

On the second question, Federal Circuit judges agreed with Lexmark that its rights had not been exhausted when it sold its products abroad, giving it the green light to sue for infringement when Impression imported its cartridges, refilled them and sold them in the United States without permission.

The Supreme Court weighs in

The Supreme Court agreed to hear Impression’s appeal, prompting more than 30 IP owners, industry associations and academics to file amicus briefs offering their advice to its justices.

The Imaging Supplies Coalition, representing multinational printer companies, urged the Court to uphold the Federal Circuit’s decision. It argued that both rights holders and consumers benefit from a rule of patent exhaustion that allows for valid use restrictions, and that national exhaustion supports international economic development by allowing patent owners to set different prices around the globe.

These arguments were also backed by associations representing pharmaceutical and biotech companies – enterprises that place price differentials at the heart of their global pricing strategy and rely on the doctrine of patent exhaustion to police that strategy. BIO and Croplife International, for example, claimed that if the Supreme Court placed any limitation on the doctrine of exhaustion it could enable arbitraging of cheaper products. “Any benefits to US consumers,” the brief read, “would likely accrue at the expense of poorer consumers elsewhere.”

Associations representing businesses that repair and resell patented products hit back. The Owners’ Rights initiative, a coalition that includes eBay and the Association of Service and Computer Dealers International, argued that if the Federal Court decision was to stand, “title to millions of items of personal property will be clouded, a pall will be cast over resale and rental markets, and infringement litigation floodgates will open”.

It was in this legal and policy context that the Supreme Court reached its decision on the two questions before it. Its answer was clear: “patent exhaustion is uniform and automatic.”

It went on: “We conclude that a patentee’s decision to sell a product exhausts all of its patent rights in that item, regardless of any restrictions the patentee purports to impose or the location of the sale… [R]estrictions and location are irrelevant; what matters is the patentee’s decision to make a sale.”

On the question of domestic patent exhaustion, the Court ruled that a patent owner exhausts their rights when they sell a patented product. While Lexmark can use contract law to restrict what a customer does with a product it has purchased, the IP owner cannot bring an action for patent infringement.

On the second question, the Court ruled that an authorized sale outside the United States exhausts all patent rights, just as if the sale had been made in the US. In practice, patent owners will now no longer be able to rely on patent law to help them prevent arbitragers from buying their products cheaply overseas and importing them into the United States to resell them.

Changing landscape

What does the ruling mean for business? It has been welcomed by companies that want to get a slice of the repair and spare parts market. Patent owners who seek to protect their after-sales markets have seen their options shrink. Now they will need to rely more heavily on contractual terms to limit what customers can do with their purchases. In-house lawyers are likely to be busy over the next few months beefing up provisions in their companies’ end user license agreements. Given the practical difficulties of enforcing such terms, however, many patent owners will ramp up the game of technological catch-up that they play with competitors, placing ever-more sophisticated practical barriers such as digital rights management tools in their way.

But the decision also poses big challenges to the way that companies in other industries, particularly in the pharmaceutical sector, run their businesses. Traditionally, originator drug companies have priced high in the United States and low in developing countries, where political and public relations pressures (as well as price-capping regulations) often encourage them to supply medicines at a cost that local consumers are better able to afford. Now there will be fewer legal blocks in the way of third parties who want to buy their products cheaply overseas and sell them into the United States. Mark Grayson of Phrma, which represents many big US drugs companies, says the organization is still evaluating its next steps in the light of the decision.

So what are the options for patent owners in the sector? One may be for IP owners to press the government to include tougher patent provisions in any trade deals the US negotiates or renegotiates. Another may be to ask legislators to reform US law to give domestic IP owners more power to control what happens to their patented products. Yet another is that some companies may stop selling medicines in certain markets to minimize the risk that arbitragers buy them to resell in the United States.

What is certain is that a small company’s decision to fight a battle over refilled ink cartridges will now affect the business decisions of organizations across the United States.

The role of Kirtsaeng

Throughout the dispute loomed Kirtsaeng v. John Wiley & Sons, Inc. That case, decided by the Supreme Court in 2013, also dealt with exhaustion – this time in the context of copyright law. The dispute required the justices to decide whether a publisher could prevent books bought overseas from being resold in the US using copyright law. A majority came down on the side of Kirtsaeng, agreeing that his sale of textbooks bought overseas was protected by the so-called first-sale doctrine.

Lexmark reminded the Court that Kirtsaeng dealt with copyright law and did not mention the Patent Act. The printer company urged the justices to keep the two areas of law separate. Impression pressed the Supreme Court to reconcile Kirtsaeng with patent law, arguing that its common law determination on the first-sale doctrine applies equally to patent law.

All but one of the justices were convinced by Impression’s argument on the question of international patent exhaustion, with a dissenting opinion from Justice Ginsburg. She disagreed with the Court’s reliance on Kirtsaeng and claimed that it was too difficult to draw an analogy between patents and copyright on questions of international exhaustion because whereas copyright law is harmonized across many countries, patent law is not.

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