Placing Single Use Restrictions On The Sale Of Patented Products Can Avoid Patent Exhaustion And Maintain Market Share

Wednesday, February 1, 2006 - 01:00

A common business model involves attracting customers by selling a low cost, loss leader device which relies on a much more profitable consumable product. This model is often referred to as the "razors and blades" model because it has been employed by the Gillette Company in their sale of razor handles and disposable blades. To be successful, a business employing this approach must exercise significant control over the sale of the consumable products or risk that competitors will erode their profits.

Obtaining a patent on a feature that is critical to the consumable's compatibility with the loss leader device is an effective way of maintaining one's share in the consumables market. That is because the patent would subject any competitors making a compatible consumable to patent infringement claims.

Some competitors have entered markets for patented consumables by refurbishing the patentee's own products after they have been used by the patentee's customers. The refurbishers have defended themselves from patent infringement claims by relying on the First Sale doctrine. That doctrine generally prohibits a patentee from restricting the use or sale of a particular patented item after the patentee has sold it.

The printer manufacturer Lexmark has had recent success in court defending a program it designed to address competition from refurbishers of used Lexmark printer cartridges. As discussed below, Lexmark's program preempts the refurbishers' First Sale defense through a contractual single use restriction placed on the purchaser.

The First Sale Doctrine

The First Sale doctrine (also referred to as patent exhaustion) is an affirmative defense that limits a patentee's ability to restrict downstream use or resale of patented goods originating from the patentee. "[S]ale of [the patented item] exhausts the monopoly in that article and the patentee may not thereafter, by virtue of his patent, control the use or disposition of the article." U.S. v. Univis Lens Co., 316 U.S. 241, 250 (1942) (citations omitted). The doctrine is premised on the idea that a patentee obtains his full royalty value from the first unconditional sale of a particular patented item and cannot extract additional royalties from that particular item. Keeler v. Standard Folding Bed Co., 157 U.S. 659, 663 (1895) (for "a machine that is sold without any conditions É the rule is well established that the patentee [has] parted É with all his exclusive right, and that he ceases to have any interest whatever in the patented machine so sold"). In other words, a person who buys a product without restrictions should have the full and unfettered right to do with it as he wishes, including providing it to a refurbisher for repair.

Patentees have employed two general attacks against refurbishers' First Sale doctrine defenses. One approach is to show that the refurbishment of the patented item was so extensive that it amounts to an impermissible reconstruction of the original article as opposed to a repair. The other approach is to demonstrate that the particular item was not unconditionally transferred to the end user such that the First Sale defense does not apply.

Repair Versus Reconstruction

A patentee can defeat a refurbisher's First Sale defense if the refurbisher has "reconstructed" the patented device. But the patentee's challenge will fail if the refurbisher has merely "repaired" the device. The difference between repair and reconstruction is a matter of degree. A purchaser of a patented item is allowed to repair the device to maintain it in working order. A purchaser or refurbisher is not, however, allowed to reconstruct a new version of the patented item on the template of a spent patented item. When the patented device is spent, the purchaser's right to practice the patent ends.

In practice, however, courts seem to require an extensive reworking of a device to constitute a reconstruction and such findings are rare. The breadth of permissible repair is demonstrated by Dana Corp. v. American Precision Co., 827 F.2d 755 (Fed. Cir. 1987). In Dana, a refurbisher of patented truck clutches was stripping down used clutches to their individual parts, discarding worn or unusable parts, collecting serviceable like parts in bins, and then using the binned parts, along with new replacement parts, as needed, to manufacture "rebuilt" clutches. The Court held these activities to be permissible repair. Similarly, in Hewlett-Packard Co. v. Repeat-O-Type Stencil Mfg. Co., 123 F.3d 1445 (Fed. Cir. 1997), Repeat-O-Type's modifications of HP's patented cartridges to make them refillable was deemed permissible and akin to repair. Id. at 1452. The Court set the bar for reconstruction rather high stating, "reconstruction occurs after the patented combination, as a whole, has been spent, when ' the material of the combination ceases to exist .'" Id. ( emphasis added ), see e.g. Sandvik Aktiebolag v. E.J. Co., 121 F.3d 669 (Fed. Cir. 1997) (replacement of a worn drill tip that can no longer be sharpened found to be infringing reconstruction of the patented drill where the infringer cut the drill tip off of its shank, joined a new rectangular piece of carbide to the cylindrical shank by heating the combination to 1300 degrees Fahrenheit, and then machined the carbide piece through a number of steps to match the discarded drill tip).

Sale Restrictions Can Avoid "Patent Exhaustion"

A patentee can avoid the First Sale doctrine by not making an unrestricted sale of its patented product. For example, the patentee can contract to merely license the product to the user for a single use. Absent an unconditional sale, the patentee retains patent rights in the individual item which can later be enforced against a refurbisher. See Mallinckrodt, 976 F.2d at 709 (reversing the district court's holding that all restrictions post sale use of a patented item are unenforceable and remanding for a determination whether the patentee's single use restriction was embodied in a valid contract license term).

Avoidance of the First Sale doctrine, however, requires an actual and enforceable restricted transfer. The patentee's mere intent that the item be limited to a single use is not sufficient to prevent application of the First Sale doctrine. See, Jazz Photo Corp. v. International Trade Com'n, 264 F.3d 1094, 1107-08 (Fed. Cir. 2001) (patentee's warnings and instructions on camera that it was for single use only did not constitute a license and therefore did not avoid the First Sale doctrine); see also Hewlett-Packard, 123 F.3d at 1423 (the seller's intent, unless embodied in an enforceable contract, does not limit a purchaser's right to use, sell or modify a patented product).

A contract limiting a purchaser's rights under the contract also must not extend the patentee's rights beyond the scope of the patent. Mallinckrodt, Inc. v. Medipart, Inc., 976 F.2d 700, 704 (Fed. Cir. 1992) (patentee may enter into a valid license restricting purchaser/licensee's use of patented item, but the agreement cannot use "the patent to obtain market benefit beyond that which inheres in the statutory patent right.")

Lexmark's Program To Avoid First Sale Restrictions

Lexmark has instituted a toner cartridge sales program that addresses possible competition from refurbishers of used Lexmark printer cartridges. Under this program, Lexmark offers toner cartridges for a given printer at two different prices. Full price cartridges are offered for unrestricted sale with no conditions attached. As an alternative, Lexmark provides cartridges at a 20% discount, but subject to license restrictions embodied in a "box top license." The license printed on the outside of the box reads:

Opening of this package or using the patented cartridge inside confirms your acceptance of the following license agreement. The patented cartridge is sold at a special price subject to a restriction that it may be used only once. Following this initial use, you agree to return the empty cartridge only to Lexmark for remanufacturing and recyclingÉ. A regular priced cartridge without these terms is available.

A refurbishers' trade association challenged Lexmark's program as constituting deceptive and unfair trade practices under California law. Arizona Cartridge Remanufacturers Ass'n Inc. v. Lexmark Int'l Inc., 421 F.3d 981 (9th Cir. 2005). The Association alleged that post sale restrictions are not enforceable and that Lexmark misled customers into believing they are. The Association also alleged that Lexmark misled customers into believing that they are receiving a discount when Lexmark could not control cartridge prices.

The Court held that Lexmark's program created an enforceable contract with its customers because the customers, "(1) have notice of the condition, (2) have a chance to reject the contract on that basis and (3) receive consideration in the form of a reduced price in exchange for the limits placed on reuse of the cartridge." Id. at 988. The Court also noted that the Association did not challenge the district court's determination that Lexmark's license restrictions were within the scope of its patent rights and, thus, under Mallinckrodt did not constitute misuse. Id. at 987. Because the Lexmark program created a binding contract that did not impermissibly extend Lexmark's patent rights, the Ninth Circuit found that Lexmark retained patent rights that were enforceable against infringing refurbishers. Id. And, thus, the Ninth Circuit affirmed the district court's summary judgment dismissal of the Association's unfair competition claims.

Conclusion

Lexmark has apparently developed a viable approach to marketing patented consumables and preventing profit erosion typically caused by the entry of refurbishers into the consumables market. The key to Lexmark's success was the use of an enforceable box top license to avoid an unconditional sale of its printer cartridges. While the Ninth Circuit did not substantively address whether the Lexmark license was unenforceable for patent misuse under Mallinckrodt, the Court's decision as a whole appears to indicate that license restrictions as employed by Lexmark are enforceable.

Joseph A. Calvaruso, a Partner in Chadbourne & Parke's intellectual property department, has over 25 years of experience in virtually all aspects of intellectual property. Richard Martinelli is an Associate in Chadbourne's intellectual property department whose practice focuses on patent litigation, prosecution and client counseling.

Please email the authors at jcalvaruso@chadbourne.com or rmartinelli@chadbourne.com with questions about this article.