Federal Circuit Holds that a “Covenant Not to Sue” Authorized Sales of Patented Products Under the Doctrine of Patent Exhaustion
April 15, 2009
In an important decision published last week, the Federal Circuit affirmed a decision by the Northern District of Texas, holding that a covenant not to sue in a settlement agreement authorized sales of patented products and exhausted the plaintiff’s patent rights. Prior to this decision, the prevailing view had been that a covenant not to sue is personal in nature and, unless legislated for in the covenant itself, does not extend to downstream users of patented products. Therefore, this decision has significant implications for the drafting and interpretation of patent licenses and settlement agreements.
TransCore, LP v. Electronic Transaction Consultants Corporation, Docket Number 2008-1430 (Fed. Cir. Apr. 8, 2009)
TransCore, LP and TC License, Ltd. (collectively “TransCore”) engage in the business of manufacturing and selling automated toll-collection systems, such as “E-Z Pass” tags and readers, and hold several patents to related technologies. TransCore sued Mark IV Industries, Inc. (“Mark IV”) sometime in 2000 for patent infringement, and the suit was later resolved pursuant to a settlement agreement. As part of the settlement, Mark IV agreed to pay $4.5 million in consideration for an unconditional covenant not to sue for future infringement and a release from all existing claims.
Several years later, Electronic Transaction Consultants Corporation (“ETC”) contracted with the Illinois State Toll Highway Authority (“ISTHA”) to, among other things, install and test toll-collection systems purchased by ISTHA from Mark IV. TransCore sued ETC, claiming infringement of three patents that had been the subject of the infringement suit against Mark IV, as well as a related patent that had been pending before the United States Patent and Trademark Office but that had not yet issued at the time of settlement. ETC filed a motion for summary judgment, arguing that ETC’s activities were permitted by the settlement agreement under the doctrines of patent exhaustion, implied license, and legal estoppel. The district court agreed with ETC and entered final judgment dismissing TransCore’s claims.
Federal Circuit Decision
TransCore appealed the district court’s ruling to the Federal Circuit. The question for the Federal Circuit was whether an unconditional covenant not to sue authorizes sales by Mark IV for purposes of patent exhaustion. On the question of patent exhaustion, the court recited the rule reiterated by the United States Supreme Court in Quanta Computer, Inc. v. LG Electronics, Inc., 128 S. Ct. 2109, 2115, 2121 (2008), that “[t]he longstanding doctrine of patent exhaustion provides that the initial authorized sale of a patented item terminates all patent rights to that item,” and that “[e]xhaustion is triggered only by a sale authorized by the patent holder.”
On appeal, TransCore primarily relied on the Federal Circuit’s decision in Jacobs v. Nintendo of America, Inc., 370 F.3d 1097 (Fed. Cir. 2004), arguing that sales under a covenant not to sue in a settlement agreement are not “authorized.” However, the Federal Circuit distinguished Jacobs on the basis that the court in that case was distinguishing between settlement terms where the parties included in their agreement both a covenant not to sue and an affirmative license grant. In Jacobs, the court held, by implication, that the covenant not to sue was more limited than the license grant. In TransCore, the Federal Circuit suggested that Jacobs was decided on the contracting parties’ specific intent and that its application should be limited to cases of an implied license analysis rather than an exhaustion analysis. In the case of patent exhaustion analysis, relying on Quanta, the Federal Circuit noted that the parties’ intent with respect to downstream customers is irrelevant and, therefore, Jacobs does not apply.
The Federal Circuit instead emphasized that a nonexclusive patent license is equivalent to a covenant not to sue because the patent holder, by license or otherwise, cannot convey an affirmative right to practice its patented invention, only the freedom from suit. The court reasoned that the converse can also be true, explaining that both a covenant not to sue and a license are properly viewed as “authorizations.” Given that the terms of the covenant not to sue in the settlement agreement unambiguously authorized sales by Mark IV by providing freedom from suit for all acts that would otherwise be infringements, without placing any restrictions on making, using, offering for sale, selling or importing its automated toll-collection systems, the court ultimately concluded that exhaustion applied.
The court also affirmed that TransCore’s rights to the patent, which had not yet issued at the time of the settlement, were also exhausted by Mark IV’s authorized sales. The timing of the patent issuance was not considered to be relevant. The court applied the legal estoppel doctrine to imply a license to Mark IV given that TransCore had already received consideration for such right under the settlement agreement, and held that Mark IV’s rights under such implied license were necessarily coextensive with its rights to the other three patents and, accordingly, exhaustion applied.
The Federal Circuit held that the sales at issue were authorized under a covenant not to sue because that covenant did not contain affirmative restrictions on such sales. This will have a major impact on how patent licenses, cross-licenses and settlement agreements are drafted in the future. It is unclear whether TransCore will petition the Federal Circuit for en banc review or petition the United States Supreme Court to review the Federal Circuit’s decision. In the meantime, patent holders and their counsel will need to consider the court’s finding when drafting covenants not to sue in any such agreements. Affirmative restrictions regarding downstream use of a patent holder’s technology will need to be included in such covenants if a patent holder wants to limit such downstream use and ensure that such sales are not considered “authorized” under the covenant.
If you have any questions about the decision discussed in this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact.
Frank J. Azzopardi, Partner
Anthony I. Fenwick, Partner
William M. Kelly, Partner
Paul R. Kingsley, Partner
Matthew B. Lehr, Partner
Steven S. Weiner, Partner