Lexmark and the future of sales

In Chapter 10 of our book—spoiler alert—we urged the Supreme Court to reverse the Federal Circuit's disaster of an opinion in Lexmark v. Impression Products. We certainly aren't making any causal claims here, but shortly thereafter the Court decided to grant cert, and earlier this week it issued its opinion.

The case involved the long-running effort by Lexmark to prevent the refilling of toner cartridges for its printers. As part of that strategy, Lexmark sold patented cartridges with restrictions attached: you can only use them once, and you can't transfer them to anyone else. Anyone who broke those rules, according to Lexmark, was a patent infringer. But those limits run counter to the doctrine of patent exhaustion, which ensures owners of patented goods the right to use and alienate them free from patent-holder control. The first question for the Court, then, was whether these sorts of post-sale restrictions are enforceable as a matter of patent law. The second question was whether exhaustion applies at all to products that were first sold outside of the United States. 

As to the first question, the Federal Circuit held that the scope of exhaustion is a matter of statutory interpretation. It saw exhaustion as a sort of implied license; buyers are granted the rights to use and alienate goods only so long as the patent holder does not indicate an intent to withhold them. The Federal Circuit tied that reading to the phrase "without authority" in the Patent Act's infringement provision.

The Supreme Court rejected the notion of exhaustion as a purely, or even primarily, statutory creature. Instead, it explained that exhaustion "marks the point where patent rights yield to the common law principle against restraints on alienation." The rights that flow from exhaustion are not the patent holder's to give or withhold. Instead, they are inherent limits on the scope of the patent. When a sale occurs, it "transfers the right to use, sell, or import because those are the rights that come along with ownership." In concluding that a patent holder cannot sell a product while retaining ongoing rights to control its use or disposition, the Supreme Court rejected twenty-five years of ill-considered Federal Circuit precedent, stretching back to Mallinckrodt v. Medipart.

As to the second question, Lexmark argued, and the Federal Circuit agreed, that sales made outside of the United States did not exhaust the patent holder's control over use and alienation. In 2001 in Jazz Photo, the Federal Circuit held that foreign sales did not exhaust U.S. patent rights. That decision relied largely on misrepresenting the facts and holding of the Supreme Court's only other international patent exhaustion case, Boesch v. Graff, from 1890. Crucially, that case did not involve a sale by the U.S. patent owner, rather the sales were made by a prior user entitled to make the product under German law. Boesch, the Court rightly noted, tells us nothing about whether a foreign sale made or authorized by the patent holder triggers exhaustion. Instead, as it did in Kirtsaeng v. John Wiley & Sons, the Court recognized that "the common law’s refusal to permit restraints on the alienation of chattels," the principle animating both patent and copyright exhaustion, "makes no geographical distinctions.”

As the Court succinctly put it, "restrictions and location are irrelevant; what matters is the patentee’s decision to make a sale." So in one opinion, the Supreme Court upended two pillars of Federal Circuit patent exhaustion case law. What does that mean going forward?

The immediate upshot of the decision is that consumers will have more freedom to use the products they buy in the way they see fit. They will also benefit from greater competition and lower prices as remanufactures like Impression Products enter the market without the risk of patent infringement suits.

Some worry that the loss of control patent holders have enjoyed over the past few decades will lead to changes that will instead harm consumers. Won't companies like Lexmark just raise their prices on new toner cartridges? Perhaps, but I think it is doubtful for a couple of reasons. First, Lexmark already sold unrestricted cartridges, for only about 20% more than the single-use variety. Second, raising the price on new cartridges may well steer more consumers to cheaper remanufactured alternatives, at least in the short term.

Another potential concern is that companies like Lexmark will stop selling products altogether and move to lease, rental, or subscription models that don't entail transfers of ownership to consumers. We've seen the software and digital media markets embrace these models in recent years. But aside from the legal benefits of avoiding sales, those models benefitted from the economics of digital distribution. At least until 3D printing becomes a widespread reality, the distribution of most patented goods will remain decidedly tangible. If so, leasing models won't be very appealing, especially for low-dollar-value goods. Patent holders would need to create and enforce systems for collecting ongoing payments and expired products from consumers, an expense likely not justified by the harm of secondary markets. Of course, exactly how much of an expense such a model would entail depends on how courts define a "sale" going forward.

The Court in Lexmark didn't directly tackle the question of what exactly constitutes a sale. In the copyright space, software companies have been able to convince some courts that simply dubbing a transaction a "license"—even when it is a one-time payment in exchange for perpetual possession—is enough to avoid a sale and exhaustion. If trivial changes to the wording of Lexmark's labels—essentially replacing "post-sale restriction" with "license"—were sufficient, the Court's opinion won't have much lasting effect. 

So what can we glean from the Court's opinion when it comes to sales? For one we know that a transaction still counts as a sale if the seller attempts to to attach restrictions. And we know it is still a sale if the seller explicitly reserves its patent rights. More precisely, we know that restrictions on alienation and use of the patented good are not enough to overcome a sale. That's important because the Ninth Circuit's deeply-flawed approach in Vernor v. Autodesk looks to three factors to determine whether a "license" or a sale has occurred. They are whether the copyright holder:

 (1) specifies that the user is granted a license;

(2) significantly restricts the user's ability to transfer the software; and

(3) imposes notable use restrictions.

Lexmark's restrictions applied to the use of the cartridges and to their transfer. In fact, the only thing that sets Lexmark's restrictions apart from Autodesk's is the use of the magic word "license." Unless the Supreme Court's full-throated embrace of patent exhaustion was nothing more than an exercise in empty formalism, Lexmark seems to suggest that the Vernor test is misguided. If that's right, Lexmark may actually help clarify the longstanding murkiness in copyright law over the license/sale distinction.