VOICES FROM THE INDUSTRY: Avoid a royalty mess by reviewing your patent license

The U.S. Supreme Court’s recent decision in Quanta Computer v. LG Electronics left LG stuck in “a royalty mess” that should inspire local businesses to review their patent licenses.

More specifically, the decision raises important questions about the extent to which-and the cir
cumstances under which-patent owners can collect royalties from more than one party in the distribution chain. Although the case arose out of the IT industry, its lessons could significantly impact Indiana life sciences companies.

Collecting downstream

In Quanta, the Supreme Court rejected LG’s effort to collect patent royalties not only from its direct customer, Intel, but also from computer manufacturers further downstream who incorporated Intel’s microprocessors into their own products-namely, personal computers.

The court held that LG’s license to Intel to manufacture microprocessors that substantially embodied the patents, and could only be used in an arrangement that would infringe the patents, “exhausted” LG’s patent rights. In turn, LG could not seek any royalties from Intel’s customers. The Court reached this conclusion even though LG had required Intel to warn its customers that they did not have a license to LG’s patents, and Intel had done so.

Nonetheless, the court’s decision may have left the door ajar for patentees to collect royalties from customers of their customers. Even though the court applied the exhaustion doctrine to method patents, it was still important that LG had authorized Intel’s sales of the microprocessors embodying LG’s patents. LG had simply required Intel to warn the latter’s customers that they did not have a license from LG; it did not otherwise condition or prohibit Intel’s sales.

In the court’s view, Intel’s sales subject to the warning were authorized and exhausted LG’s rights.

Review your contracts

In light of this case, IT and life sciences companies should review any contractual documents (licenses, purchase orders, etc.) they use to buy or sell patented products. At a minimum, a seller who wants to condition a buyer’s use or resale of a patented product should ensure the contract terms are stronger than those used by LG, which were found insufficient.

On the other hand, a buyer of patented products should now determine if it can use or resell them with fewer restrictions than before Quanta. It is now clear that contract language such as that used by LG will not avoid the exhaustion doctrine. Rather, any use or downstream sale of the patented product should be expressly conditioned on the subsequent user or purchaser having acquired its own license directly from the patent owner-or some other desired outcome.

In light of Quanta, experts have also
speculated whether the Supreme Court will continue to allow patent owners to avoid the exhaustion doctrine by granting restricted or conditional licenses.

Hoosier impact

In Indiana, the enforceability of conditional licenses is important to our economy because, for example, sales of genetically modified seeds and disposable medical diagnostic devices are often made under such licenses. Indeed, earlier this, Monsanto prevailed in a patent-infringement case over a farmer who saved some
herbicide-resistant soybean seeds from one season to replant the next. It has been reported the farmer is now seeking Supreme Court review of the case, so we may not have to wonder much longer about the validity of such practices.

Another related issue is whether the sale of a patented product internationally exhausts U.S. patent rights, so that the product can be re-imported and resold in the United States free of a patent infringement claim. Of course, this is of great interest to Indiana’s pharmaceutical companies, among others. Again, the Federal
Circuit currently has sided with the patent owners on this issue.

As Indiana continues to grow its economy on innovation, companies must stay abreast of and react to important patent and copyright decisions such as Quanta. They should consider bolstering contractual prohibitions on patents while reviewing contracts. After all, inactivity has never been a friend of innovation.