Exhaustion of Rights and the Conditional Sale of Protected Articles

The doctrine of exhaustion of rights or “first sale” is usually applied to prohibit a proprietor from imposing restrictions regarding the onward sale of an article that is the subject of a patent or registered design, where a party has purchased that article lawfully from the proprietor or his authorized agent. The basis of the doctrine is that the sale of an article does not grant the purchaser any rights in the intellectual property related to the article but rather extinguishes the proprietor’s entitlement to control the movement of an article embodying that intellectual property, after the article is first sold.

Where a country recognizes a doctrine of national exhaustion of rights, an intellectual property proprietor’s right to control movement of a protected article is extinguished by the first sale of the article within that country. Where a country recognizes regional or international exhaustion of rights, an intellectual property proprietor’s right to control movement of a protected article is extinguished when the article is first sold anywhere in the region or in the world, respectively.

The South African Patents and Designs Acts[1] do expressly recognise the doctrine of exhaustion of rights. However, the wording of the relevant sections does give rise to uncertainty as to whether the doctrine is to apply nationally or internationally[2].

The only South African judgment on this topic[3] endorses the view adopted in the age-old US case of Dickerson v Matheson, 57 FD 524 (C. C. A. 2d, 1893) in which it was determined that:

“a purchaser in a foreign country of an article patented in that country and also in the United States, from a licensee under the foreign patent only, does not give the purchaser the right to import the article into, and sell it in, the United States, without the licence or consent of the owner of the United States patent.”

In other words, South African law recognises the doctrine of exhaustion of rights as it is applied within South Africa (i.e. in respect of an article first sold and re-sold within South Africa). It does not, however, recognize exhaustion of rights where the article is first purchased outside South Africa with the consent of the foreign patent holder (or his licensee) but is resold in South Africa without the South African patent owner’s consent.

So in certain circumstances, the proprietor of an intellectual property right is unable to impose a restriction on how the purchaser deals with a protected article after the sale. However, the purchaser may agree to certain restrictions when buying the article. In these instances, would the parties be entitled to ‘contract out’ of the implications of the doctrine?

United States court decisions are most enlightening (but not decisive) on this topic. The decision in Adams v. Burke, 84 U.S. (17 Wall.) 453, 456 (1873) stood, for over a century, as authority for the principle that a patentee is unable to place restrictions on the use of a patented article after sale. The court held that “in the essential nature of things, when the patentee, or the person having his rights, sells a machine or instrument whose sole value is in its use, he receives the consideration for its use and he parts with the right to restrict that use.”

Some 80 years later, the US Supreme Court came to the same conclusion in United States v Univis Lens 316 U.S. 241 (1942). In this case, the patentee attempted, in its licence agreement, to fix the price of lenses that were on-sold (in finished form) by its licensees to the public. The court held as follows:

“We think that all the considerations which support these results lead to the conclusion that where one has sold an uncompleted article which, because it embodies essential features of his patented invention, is within the protection of his patent, and has destined the article to be finished by the purchaser in conformity to the patent, he has sold his invention so far as it is or may be embodied in that particular article. The reward he has demanded and received is for the article and the invention which it embodies and which his vendee is to practice upon it. He has thus parted with his right to assert the patent monopoly with respect to it and is no longer free to control the price at which it may be sold either in its unfinished or finished form.”

More recently however, in Mallinckrodt Inc. v. Medipart, Inc., 976 F.2d 700 (Fed. Cir. 1992), the Federal Circuit broke from earlier precedents by interpreting the sale of a patented article as a form of implied licence to use the article. In this dispute, Mallinckrodt sold patented inhalers to hospitals subject to a notice that they were for "single use only." The hospitals disregarded that notice and permitted the defendant, to collect the used inhalers from the hospitals, recondition them, and sell them back to the hospitals for reuse. When Mallinckrodt sued the hospitals for infringement, the district court held that all restrictions on a purchaser's use of patented goods were invalid as a matter of law, and therefore the "single use" notice placed on the inhalers was per se invalid and unenforceable.

The Court of Appeals for the Federal Circuit (CAFC) reversed the decision of the lower court and decided, on the question on the enforceability of the single-use notice, that conditioning a sale on an agreement to post-sale conditions is a legitimate exercise of patent rights if:

(1) the restrictions are reasonably within the patent grant;

(2) the restrictions do not violate some other policy such as patent misuse or antitrust; and

(3) the restrictions do not cause an anti-competitive effect beyond the rule of reason. The CAFC has cited its Mallinckrodt decision favourably in subsequent cases[4].

In this century, the question again arose in a dispute between Quanta Computer and LG Electronics. Intel Corporation was licensed under a set of LG patents, but according to the agreement between Intel and LG, Intel and any of it’s customers that bought the chips (although the latter were not party to the agreement) were prohibited from combining the chips made according to LG’s patents with non-Intel products. Intel sold the chips to Quanta and despite explaining the provisions of the Intel-LG agreement, Quanta proceeded to combine the chips purchased from Intel with non-Intel components. As a result LG sued Quanta, asserting that the combination of its chips with other computer components infringed its patents.

The district court decided that Quanta’s purchase of the chips from Intel was unconditional because it was in no way conditional to their agreement not to combine the Intel chips with other non-Intel parts and then sell the combined products. The Federal Circuit disagreed with the district court, explaining that although Intel was free to sell its chips, those sales were only authorised by the licence, where they were subsequently combined with Intel products.

In the Federal Circuit decision, the court pointed to two possible sales that could potentially create an exhaustion of patent rights. First, prior to the dispute, LG granted Intel a license covering its entire portfolio of patents on computer systems and components. This transaction constitutes a ‘sale’ for exhaustion purposes. Second, with LG’s authorization, Intel sold its chips to Quanta. It was this second sale that the district court relied upon as an exhausting sale.

LG argued that the exhaustion of the patentee’s rights “does not apply to an expressly conditional sale or license”, which is in line with the Mallinckrodt decision. Quanta Computer’s counter-argument was that LG is not entitled to enforce its rights on the basis of patent infringement since it would be absurd to allow LG “to sue Intel’s customers—and their customers, and their customers, down through the chain all the way to end consumers—for patent infringement, based on the theory that it did not convey an express or implied “license” to Intel’s purchasers”.

Importantly, LG has not denied the right of a patentee to condition the sale of a patented article upon certain after-sale restrictions. It merely asserts that the patentee must enforce the contractual promises it has obtained from the purchaser, by suing for breach of contract and not for patent infringement, much like any ordinary seller would have to do.

At the time that this article was submitted for publication, the matter was yet to be finally decided since in September of 2007 the US Supreme Court accepted Quanta’s petition to consider whether the LG-Intel agreement and Intel’s sale to Quanta exhausts LG’s rights over its patented chips.

In conclusion, the most recent US decisions provide evidence to suggest that parties are able to ‘contract out’ of exhaustion of rights. In fact, the Mallinckrodt decision suggests that not only can a seller place conditions on the use and enjoyment of the article purchased, but that a tacit agreement that comes into existence between the parties by way of a notice displayed on the product, is sufficient to bind the purchaser to these conditions. Further, a patentee’s rights are not necessarily exhausted in the case where the sale or licence is conditional upon certain after-sale restrictions – although the decision of the US Supreme Court in the Quanta-LG matter will be enlightening on this question. In any event, a patentee would always be entitled to enforce its rights on the basis of contract law, as any seller of a non-patented article would similarly be entitled to do.

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[1] Patents Act 57 of 1978 and Designs Act 195 of 1993

[2] Section 45(2) of the Patents Act stipulates that “The disposal of a patented article by or on behalf of a patentee or his licensee shall, subject to other patent rights give the purchaser the right to use, offer to dispose of and dispose of that article.” While “patentee” is defined to be the proprietor of a patent granted in the Republic, the term “licensee” is undefined in the Act and could accordingly be interpreted to mean a licensee under a corresponding foreign patent.

[3] Stauffer Chemical Company v Agricura Limited 1979 BP 168 (CP)

[4] McCoy v. Mitsuboshi Cutlery Inc., 36 USPQ2d 1289 (Fed. Cir. 1995); and Kendall Co. v. Progressive Medical Technology Inc., 38 USPQ2d 1917 (Fed. Cir. 1996)

Dina Biagio

Spoor & Fisher

Date published: 2008/07/07
Author: Dina Biagio

Tags: rights conditional sale protected articles