A lengthy tug of war between the Supreme Court and the Federal Circuit Court of Appeals may have ended with Impression Products v. Lexmark (2017). The Supreme Court held that the sale of a patented thing exhausts the patentee seller’s rights to enforce restrictions on that thing through patent infringement suits. Further, the parties cannot bargain around this rule through the seller’s specification of conditions, no matter how clear. No inquiry need be made into the patentee’s market power, anticompetitive effects, or other types of harms, whether enforcement of the condition is socially costly or valuable, or has a positive or negative impact on innovation. None of this is relevant.
Lexmark had imposed a patent condition intended to prohibit anyone other than itself from refilling its reusable printer toner cartridges. In antitrust parlance this was a variable proportion tying arrangement, tying the printer to the cartridges. Today most people believe that such arrangements are efficient, and largely everyone agrees that they are economically beneficial when they are imposed by a nonmonopolist, as Lexmark was in this case. It holds a relatively small share of the highly competitive market for computer printers. In a variable proportion tie, the seller typically lowers the price of the tying product (the printer) but charges a higher price for the tied product (the toner cartridge), effectively obtaining a higher rate of return from higher intensity users. Such an arrangement, at least when imposed by a nonmonopolist, generally increases output. Nevertheless, the Supreme Court’s draconian rule made this restriction unenforceable per se. Sometimes a contract restraint can do the same work as a patent license restriction, but a contract can be enforced only against those in privity, which in this case would be thousands of end users whose violations would be virtually impossible to detect.
The patent exhaustion doctrine is judge made, mentioned nowhere in the Patent Act. A judge made amendment should repair some deficiency in the underlying statute, and it should be justified by the same authority that the Constitution gave Congress to enact the legislation in the first place. That is, it should promote innovation, perhaps competition, or some value that furthers innovation policy. Historically the doctrine was properly used to limit retroactive patent enforcement in situations where enforcement impaired both innovation and competition. Later, the doctrine reflected concerns for federalism by preserving the power of state commercial law to control the use of things, whether or not they were patented. As enforced today, however, the exhaustion doctrine is a rule in search of a principle.
The rationale that the Supreme Court gave for its draconian rule was the common law policy against restraints on alienation, articulated in England by Lord Edward Coke and later developed by American John Chipman Gray in two important legal treatises. Although the Lexmark opinion purported to be “applying” the common law policy, in fact the common law rules governing alienation restraints were far less draconian than the one that the Court adopted. At common law restraints limited as to time were routinely upheld, particularly in the United States. The enforcement life of a patent license is limited to the duration of the patent, rarely exceeding 18 or 20 years. In any event, the common law doctrine was devoted almost entirely to concerns over preservation of family wealth and not as a control over either commercial distribution or innovation. In antitrust law, the Supreme Court had relied on a policy of limiting alienation restraints to strike down commercial vertical restraints in the 1960s, but had long since abandoned it in favor of a more economic approach.
Impression Products reveals an economic deficiency that manifests all too frequently when patent law is brought to bear on market practices. Economic concepts such as market power or output effects which are commonly used in antitrust law are virtually unknown in patent law. This fact has inclined courts to go to wild extremes—such as equating every patent with monopoly, or concluding that a patent is a mere property right and that anything done within the scope of the patent is permissible. The result, as in this case, can be draconian rules that are indifferent to effects on innovation, competition, economic efficiency, or any other measure that seems relevant to innovation policy. The Supreme Court would have been wise to develop a more nuanced exhaustion rule that examines actual effects on innovation or competition likely to result from a particular restraint. The antitrust law of restricted distribution began in a similar place, adopting categorical per se rules that were relaxed as our understanding of the economics of restricted distribution changed. Even a quick examination of the types of restraints imposed in exhaustion cases indicates that they are used for many different purposes and with different effects. The Impression Products decision was wrong to make these differences irrelevant.
Herbert Hovenkamp is James G. Dinan University Professor, Penn Law and Wharton Business, University of Pennsylvania. The full Reasonable Patent Exhaustion article from JREG Volume 35 can be read here