On June 8, 2008, the United States Supreme Court issued an important and far-reaching patent decision pertaining to the doctrine of patent exhaustion. [1] The decision strengthened the 150-year-old rule limiting a patent owner’s ability to partition product markets and to derive separate revenues for different uses of its patented technology by downstream purchasers.

The Supreme Court held in Quanta Computer, 128 S. Ct. 2109, 170 L. Ed. 2d 996, 2008 U.S. LEXIS 4702 (June 9, 2008), that the first sale or license of a patented invention by a component manufacturer also extinguished patent rights to the method of using a product that embodied or utilized the licensed component. The Court also clarified that the doctrine of patent exhaustion extinguishes patent rights to the invention when an incomplete component is licensed or sold, so long as that component “substantially embodies” the patented method or invention, and the only step necessary to practice the patent is application of common processes or the addition of standard components or parts. The Court refused to follow a formalistic approach to claim analysis and did not consider patent to be exhausted only when the device that practices the invention literally includes all patent claim elements. Finally, the Court also considered whether the doctrine of exhaustion was triggered by a license agreement that required a component manufacturer to warn purchasers that their use of the purchased component with other devices was not licensed or permitted by the patentee. The Court held that this arrangement could not avoid application of the doctrine of exhaustion because it failed to impose a “restricted use” contractual limitation on the component manufacturer, and therefore extinguished patentee’s right to assert patent infringement claims against downstream purchasers of the component.

While the decision has left some important questions unanswered, it is expected to have a significant impact on the structure of future license agreements and conduct of negotiations between many patent owners and component manufacturers of patented technology.

Overview of the Supreme Court Decision

On January 9, 2007, the U.S. Supreme Court decided a case that is very likely to have far-reaching and significant impact on patent licensing and technology transfer agreements. In MedImmune, Inc. v. Genentech, Inc.,[1] the Supreme Court removed a significant barrier for licensees that contemplate a legal action to challenge the validity or enforceability of the patents that they have licensed pursuant to an agreement with a patent owner.

In a nearly unanimous opinion (Justice Thomas being the only dissenter), the Supreme Court reversed and effectively eliminated the bright-line rule previously formulated and followed by the Court of Appeals for the Federal Circuit[2] (“Federal Circuit”). The Federal Circuit, consistent with its own earlier precedent in Gen-Probe Inc. v. Vysis Inc.,[3] held that MedImmune, a patent licensee, must terminate or breach its license in order to create a case or controversy necessary to pursue a declaratory judgment action in federal court and seek to have the underlying patents declared invalid, unenforceable or not infringed.

The Supreme Court reversed the Federal Circuit and overruled all prior Federal Circuit decisions to the contrary, holding that a patent licensee is not required to breach or terminate its patent license, and thereby incur the risk of possible injunction, treble damages and possible attorney fees, before seeking a declaratory judgment that challenges patents covered by the license. In addition, the Supreme Court concluded that the fact that MedImmune continued making royalty payments to Genentech “under protest” and enjoyed protection against infringement pursuant to a license agreement did not strip MedImmune of standing[4] to challenge the covered patents in a declaratory judgment action.

The Court’s decision in MedImmune has left open a number of unsettled issues, but it is very likely to have important business implications for both patent owners and licensees, who should reevaluate their existing patent licensing agreements, as well as consider the impact of this decision on future agreements and licensing negotiations.