Tuesday, May 30, 2017

Supreme Court rules against Lexmark on patent exhaustion, strengthening FTC/Apple cases against Qualcomm

The long-awaited Supreme Court ruling in Impression Products v. Lexmark International (PDF) has just been handed down. It deals with two questions related to patent exhaustion, and I was aware of it before but wanted to wait until the implications of that dispute on the smartphone cases I'm primarily interested in would be clearer. The good news is that the Supreme Court has once again overruled the Federal Circuit in a way that strengthens those defending themselves against attempts to gain excessive leverage and extract overcompensation from patents. The Supreme Court is staying its course with respect to patent matters, regardless of some patent troll lobbying groups suggesting that all those decisions would result in the demise of the American inventor (quite the opposite is the case).

Lexmark tried to leverage its patents on toner cartridges against various so-called remanufacturers (companies that buy up empty toner cartridges, refill them, and then sell the refilled cartridges). Impression Products was the last man standing at some point and took this to the Supreme Court after the Federal Circuit had decided completely in--surprise, surprise--the patent holder's favor. Of the three different levels of the federal court system, the Supreme Court took the strongest and clearest position against overleveraging/overcompensation of patents; the Federal Circuit took the very opposite position; and the district court (Southern District of Ohio) had agreed with Lexmark that exhaustion didn't apply to cartridges sold in other countries, but had sided with Impression at least with respect to cartridges Lexmark sold in the U.S. and on which it sought to impose certain restrictions.

As today's Supreme Court decision explains, the Federal Circuit "started from the premise that the exhaustion doctrine is an interpretation of the patent infringement statute, which prohibits anyone from using or selling a patented article 'without authority' from the patentee." In this statutory context, "without authority" just serves the purpose of clarification: if you have a license, you don't infringe. That's self-explanatory, if not tautological. But it's also the weakest basis on which the doctrine of patent exhaustion could stand: the Federal Circuit wanted to reduce exhaustion to merely a presumption of the patent holder granting customers and the entire downstream "authority" to use and resell a product. It would have been a weak basis for the all-important concept of patent exhaustion since patent holders could then navigate around it by just imposing some restrictions. Exhaustion would have worked in a similar way to promissory estoppel: if you don't say the wrong thing, or if you say the right thing to overcome a presumption, you're not estopped.

The Supreme Court has now made it clear that exhaustion is much stronger and much more comprehensive:

"The problem with the Federal Circuit's logic is that the exhaustion doctrine is not a presumption about the authority that comes along with a sale; it is a limit on the scope of the patentee's rights. The Patent Act gives patentees a limited exclusionary power, and exhaustion extinguishes that power. A purchaser has the right to use, sell or import an item because those are the rights that come along with ownership, not because it purchased authority to engage in those practices from the patentee."

On that basis, the Supreme Court basically held that Lexmark couldn't impose the restrictions it relied upon in this litigation, and that this wouldn't work for Lexmark even if the first sale occurred outside the United States (the one scenario of the two in which the district court sided with Lexmark). The Supreme Court's disagreement with the Federal Circuit is very visible in this passage, too:

"The Patent Act promotes innovation by allowing inventors to secure the financial rewards for their inventions. Once a patentee sells an item, it has secured that reward, and the patent laws provide no basis for restraining the use and enjoyment of the product."

No overcompensation. No overleveraging. No double-dipping. No restrictions that go beyond what the Patent Act allows. That's the message here.

Presumably, some people in another Washington DC building are now reading the Supreme Court decision: the lawyers working on the FTC's case against Qualcomm. The FTC argued in its January complaint, under a headline that describes Qualcomm's "no license-no chips" policy as "anomalous among component suppliers," that "when one of Qualcomm's competitors sells a baseband processor to an OEM, the OEM can use or resell the processor without obtaining a separate patent license from the competitor—just as a consumer buying a smartphone does not have to obtain a separate patent license from the seller of the smartphone." The FTC went on to explain that "Qualcomm is unique in requiring an OEM, as a condition of sale, to secure a separate patent license requiring royalty payments for handsets that use a competitor's components." For example, this would apply to a situation in which a device maker is a customer of Qualcomm and, say, Intel or Samsung's component business.

The FTC still has to make an antitrust argument here (tying), which includes that it has to prove Qualcomm's monopoly-like power in the baseband chipset business, but at least Qualcomm can't just point to the (now-reversed) Federal Circuit decision in disputing the FTC's exhaustion argument.

Patent exhaustion as a concept has been strengthened today, and its profile in certain other cases will likely be even higher now. While Apple takes certain positions when it enforces its own patents (and would rather avoid Supreme Court review of a highly controversial Federal Circuit decision in its favor), exhaustion is not an issue in Apple v. Samsung but it does play a role in Apple v. Qualcomm: Count XXIII of Apple's antitrust complaint against Qualcomm is a request for judicial "declaration of unenforceability [of Qualcomm's patents in certain contexts] due to exhaustion." Apple alleged in its January complaint that "Qualcomm has sought, and continues to seek, separate patent license fees from Apple's [contract manufacturers] for patents embodied in the chipsets Qualcomm sells to Apple's CMs, a practice that is prohibited under the patent exhaustion doctrine." In the past, Apple had to pay those license fees indirectly (via its contract manufacturers), which it is no longer prepared to do, and that's why Qualcomm is now suing four Apple contract manufacturers and seeking a preliminary injunction against them.

Apple also wrote that "[b]y requiring Apple's CMs to take a separate patent license for the same components that they purchase, Qualcomm is double-dipping." That term is an accusation against Qualcomm that I previously heard from other industry players, so I wasn't surprised to also find it in Apple's complaint. If the Federal Circuit ruling in Lexmark had been affirmed, Qualcomm might have been able to defeat that particular count of Apple's complaint. Apple's complaint already anticipated that Qualcomm would point to its corporate structure: "Qualcomm has attempted to evade the patent exhaustion doctrine by selling baseband processor chipsets to Apple's [contract manufacturers] through QTC, which is operated by QTI, which is in turn a wholly owned subsidiary of Qualcomm." Apple then points to Qualcomm's 2012 restructuring, which I already blogged about back then with a focus on open-source licensing issues. The Supreme Court's broad and inclusive approach to exhaustion simply doesn't allow any kind of end-run around the exhaustion doctrine through a first sale outside the United States as in one of the two issues relevant in the Lexmark case. Philosophically, this also makes it hard to imagine that an end-run could be achieved through a sophisticated corporate structure.

As the district court cases in Northern (FTC v. Qualcomm) and Southern (Apple v. Qualcomm) California unfold, patent exhaustion is going to be a very interesting part of the debate. And in many other cases, though the Qualcomm cases are currently the highest-profile smartphone-related cases in which exhaustion plays a role.

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