Distribution, Competition, and Antitrust / IP Law

Non-Payment of Patent Royalties Doesn’t Render Sales “Unauthorized”

Patent exhaustion is triggered by a sale “authorized” by the patent holder.  Quanta Computer, Inc. v. LG Elecs., Inc., 553 U.S. 617, 636, 128 S. Ct. 2109  (2008).  I previously covered the doctrine of patent exhaustion here and here.  The doctrine prevents patentees from enforcing patent rights against downstream product purchasers.

In Tessera, Inc. v. ITC, 646 F.3d 1357 (Fed. Cir. 2011), the Federal Circuit held the doctrine of patent exhaustion applies even when a licensee has not yet paid royalties (or has been late paying some royalties).  This Tuesday, the Supreme Court declined to review the Federal Circuit’s decision.

According to the Federal Circuit, there was “nothing in any of the license agreements [at issue] to even remotely suggest that the existence of a condition subsequent, namely, the payment of royalties, operates to convert initial authorized sales into unauthorized sales for purposes of patent exhaustion.”  In focusing on whether the sales were authorized, the Federal Circuit noted that the license agreements expressly authorized licensees to sell licensed products and to pay up at the end of a reporting period.  A subsequent non-payment of royalties would be a licensor/licensee dispute, not a licensor/licensee’s customer dispute.  The Federal Circuit found Tessera’s argument that the sale is initially unauthorized until it receives the royalty payment to be “hollow and unpersuasive.”

Could any non-payment of royalties prevent application of the exhaustion doctrine?  This is not entirely clear, I would say.  One can imagine very clear and precise license language that demonstrates the parties’ express agreement that no sale is authorized until all royalties are paid.  That case, however, has not yet been decided.

(Disclosure: Orrick represented some of the downstream chip manufacturers/purchasers in the Tessera case.)

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About Howard Ullman

Antitrust, competition, and IP law enthusiast.

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