Patent Law Blog (Patently-O)

Supreme Court Does not Decide Costco v. Omega Int'l Exhaustion Case

Costco v. Omega (Supreme Court 2010)

In Costco, the Supreme Court was asked to apply the first sale doctrine of copyright law in the context of international sales. Costco had purchased legitimate Omega watches abroad and then imported them into the US.  The watches included a small copyrighted design on the back surface and Omega argued that the importation and further distribution of the watches constituted copyright infringement.  Ordinarily, the purchaser of a legitimate copy of a work can lawfully resell the copy based on the first sale doctrine (also known as copyright exhaustion). The trick, however, is that copyright is territorial in nature and the first sale abroad arguably did not “exhaust” the US copyright. The 9^th  Circuit had sided with Omega — holding that the first sale doctrine did not apply to foreign manufactured copies that were purchased abroad.

Without opinion, and in a 4–4 split, the Supreme Court has affirmed the 9^th  Circuit decision. However, because of the 4–4 split, the case will not be seen as precedent-setting. Thus, as Ryan Vacca wrote in an e-mail this morning: “Our unanswered questions . . . remain unanswered.”

 

Guest Post: Copyrights, Patents, and International Exhaustion

By Professor Ryan Vacca

Last week, the Supreme Court heard oral arguments in Costco Wholesale Corporation v. Omega, S.A., to determine whether copyrighted works first sold in Switzerland and then imported into the U.S. infringed the copyright owner's right of distribution or whether the first sale doctrine (aka the exhaustion doctrine) applied to make the importation non-infringing.

The facts are fairly straightforward.  Omega is a watch company that manufactures watches in Switzerland.  Omega owns a copyright in a small visual image that is laser-engraved onto each Swiss-manufactured watch.  Costco, a U.S. warehouse retailer, acquired genuine Omega watches from a third party, who had purchased them from an authorized Omega distributor abroad.  Costco subsequently sold these watches in the United States.  Omega alleged that Costco's sale of these watches infringed its exclusive right to distribute copies of its copyrighted work under § 106(3) of the Copyright Act because § 602(a)(1) provides that:

Importation into the United States, without the authority of the owner of the copyright under this title, of copies … of a work that have been acquired outside the United States is an infringement of the exclusive right to distribute copies … under section 106.

Costco argued that its sales in the U.S. were non-infringing under the exhaustion doctrine codified in § 109, which provides:

Notwithstanding the provisions of section 106(3), the owner of a particular copy … lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy.

As I blogged earlier and others have discussed here and here, the Court is wrestling with what the phrase "lawfully made under this title" means in § 109 of the Copyright Act.

Costco argues that goods manufactured abroad can still fall within this phrase whereas Omega argues that goods manufactured abroad are not "made under this title" unless the goods are made or sold with permission from the copyright owner to import the goods into the United States. At oral argument, the Justices quickly pointed out the difficulties in these two interpretations on both a textual and policy level.

In contrast to the formidable task before the Court in the copyright context, patent law takes a relatively easier approach to the international exhaustion issue. The seminal Supreme Court case on international exhaustion under patent law is Boesch v. Graff, 133 U.S. 697 (1890). In Boesch, the plaintiffs held a U.S. patent and German patent for an improvement to lamp burners. The defendants purchased burners in Germany from Mr. Hecht, who was authorized to make these burners in Germany because of Germany's prior user defense (Hecht was not authorized by the patentees). When the defendants imported these burners into the U.S., the patentees sued for infringement. The defendants argued that their legal purchase in Germany from Mr. Hecht permitted them to import and sell them in the United States. The Court disagreed and held that although Mr. Hecht had a right to make and sell the burners in Germany under German patent law, this had no effect on the U.S. patentee's ability to enforce its U.S. patent in the United States.

Over a century later, the issue of international patent exhaustion arose again in Jazz Photo v. ITC, 264 F.3d 1094 (Fed. Cir. 2001) and Fuji Photo Film v. Jazz Photo, 394 F.3d 1368 (2005), where the Federal Circuit reaffirmed the Supreme Court's holding in Boesch and clarified that the exhaustion doctrine would not apply even if the U.S. patentee or its licensees authorized the first sale abroad. In other words, even if the U.S. patentee permitted the first sale in a foreign country, a subsequent attempt to import such an item into the U.S. would still constitute infringement. In support of its holding, the Federal Circuit noted that the U.S. patentee's "foreign sales can never occur under a United States patent because the United States patent system does not provide for extraterritorial effect."

Based on the dialogue between the Justices and the attorneys in Costco, it appears that the Court may be uncomfortable limiting the exhaustion doctrine in the copyright context solely to situations where the first sale took place within the United States. They seem to be struggling to articulate a standard that allows some foreign sales to take advantage of the exhaustion doctrine while giving the phrase "lawfully made under this title" some meaning.

If, in the end, the rule announced by the Court in Costco differs from the holdings in Boesch and Jazz Photo, then what effect may this have on the future of patent law's exhaustion doctrine? Of course, the Court could maintain a dual approach, where copyright exhaustion and patent exhaustion are treated differently. However, if presented with an international patent exhaustion case, the Court could rely on its Costco holding and try to align the copyright and patent rules. We have seen the Court take this approach recently in MGM Studios v. Grokster, 545 U.S. 913 (2005), when it created a new theory of secondary liability in copyright law (the inducement theory) by relying, in large part, on patent law's recognition of this theory via statute in § 271(a) of the Patent Act.

Another possibility for harmonization of copyright and patent law is that the Court takes its cue from patent law and hold that exhaustion in the copyright context only applies when the copyrighted works were first sold or otherwise distributed in the United States. If this disrupts the policy concerns underlying the exhaustion doctrine, then Congress can always step in to resolve this issue.

Reading Quanta Narrowly

David McGowan is a law professor at the University of San Diego School of Law. Much of his research involves the interplay between new technologies and antitrust law. I asked him to comments on the Supreme Court’s recent patent-antitrust decision: Quanta.

By David McGowan

To the extent possible, parties and not courts should set the terms for practicing inventions.  Parties have better information than courts; they are likely to set more efficient terms.  The Supreme Court’s opinion in Quanta Computer, Inc. v. LG Electronics, Inc, does not embrace this principle, though it may not reject it very broadly. The opinion may and should be narrowly construed.

I presume readers of this blog are generally familiar with the ruling. Intel took from LG electronics a license providing Intel a defense to infringement and immunity from contributory infringement by Intel’s customers, who knew Intel’s license did not extend to them.  The Court nevertheless held the Intel license exhausted LG’s rights insofar as Intel chips were concerned.

The Court’s analysis on the main point is too formal. Because the chips embodied substantially all the relevant LG inventions and had no substantial use unrelated to practicing those inventions, the Court thought it irrelevant that Intel customers knew their chips implied no LG license.

But an invention is an intellectual achievement distinct from its embodiment in a product.   There is no logical reason the sale of a product should exhaust rights in an invention.  There is a logical objection: Forcing patentees to load up initial sales with all the terms necessary to tailor rights to potential uses will tend to increase transaction costs of initial licenses and probably result in lumpier, less tailored contracting in general.  Better to let Intel buy its peace at a price that reflects its business and let its customers do the same. 

The statute does not compel the Court’s holding, which rests on history.  The Court should have limited rather than extended the cases it relied on.  These, such as Bauer and Motion Picture Patents, invoked exhaustion to defeat post-sale restrictions on use of a product.  But such restrictions may facilitate price discrimination or make sense for other business reasons.  Intel and LG, and firms like them, know better than courts when this is the case. 

Against this it might be argued that a robust exhaustion doctrine economizes on downstream transaction costs.  Conceptually that is true, and perhaps persuasive at the retail consumer level, but Quanta was not such a case.  Taken to its logical conclusion, this argument implies patentees are better off suing everyone and negotiating settlements than licensing anyone and giving up the ability to tailor terms.  That implication is perverse.

The Court’s devotion to history is odd because it has not shown much regard for history of late.  In eBay v. Mercexchange it was unimpressed by the long history of presumptive injunctive relief for infringement.  In the antitrust context, in Leegin Creative Leather it recently overruled the longstanding per se prohibition on minimum resale price maintenance.  And in Illinois Tool Works the Court reversed the relatively longstanding presumption that patents imply market power in tying cases. 

Quanta is at least in tension with Leegin and Tool Works.  Those cases recognize that post-sale restrictions may be efficient, a point Leegin makes directly and which is implicit in Section 271(d)(5) of the Patent Act, on which the Tool Works Court relied. In placing economic substance over transactional form, Leegin and Tool Works follow Continental TV, Inc. v. GTE Sylvania, which overruled the Court’s per se prohibition on vertical nonprice restraints.  Like exhaustion, that rule had been based on transactional formalism rather than economic analysis.

Both Leegin and Tool Works reject doctrines that trace to the same cluster of cases, such as Bauer and Motion Picture Patents, the Quanta Court cites favorably. Yet the Quanta Court said nothing to explain how its holding relates to antitrust precedents (or Section 271(d)(5)) recognizing that post-sale restrictions may be efficient.  One therefore might try to read Quanta as qualifying even its recent antitrust cases.

On this reading, at least insofar as pass-through restrictions are concerned Quanta implicitly qualifies the Federal Circuit’s Mallinckrodt precedent, which, in the misuse context, upholds patentees’ ability to impose lawful conditions on use.   Professor Ghosh has suggested (http://lawprofessors.typepad.com/antitrustprof_blog/2008/06/the-quandry-of.html) the Court’s footnote seven, which says exhaustion does not necessarily bar breach of contract claims, may point in this direction.

This reading of Quanta is neither compelled nor desirable.  It is possible to reconcile Quanta with the Court’s recent (and sensible) antitrust decisions by focusing on two things not at issue in Quanta. 

First, the initial license to Intel was not conditional.  The cases the Court cited also involved unconditional sales. Quanta therefore should not be read to extend to conditional licenses, and thus not to undercut Mallinckrodt directly.  Second,  Quanta presented no question regarding pass-through conditions and should not be held to govern them.  Intel merely bought immunity from suit for contributory infringement.  The Court did not stress this fact, but it is fair to repay the woodenness of its analysis with a strict reading of its holding.

A weakness of this reading is that it renders Quanta trivial.  One wonders why the Court would take a such a case.  Possibly the Court believes patent law and the Federal Circuit have got out of hand and must be reigned in.  But its majority opinions have not matched the robust commentary cert grants have prompted.  They are fairly narrow and unambitious.  So is Quanta, and it deserves to be read that way. 

First Sale Doctrine: Copyright & Patent

In some ways, the Supreme Court case of Quanta v. LGE is a symbol of the ongoing struggle between property law and contract law.  With concepts like the first sale doctrine (and the rule against perpetuities), property law has typically operated to limit dead hand and downstream control over property rights.  These limiting doctrines are largely ignored in a freedom of contract regime.

Vernor v. Autodesk (W.D. WA 2008)

A federal copyright case last week landed on the side of property & the first sale doctrine.  The court denied summary judgment to Autodesk — finding instead that Vernor may well have a legitimate right to re-sell his copies of AutoCAD. Autodesk argues that he only holds a contractual license to use the software (via shrink-wrap license) and does not actually hold full property interests in the programs.

“[T]he transfer of AutoCAD packages from Autodesk to CTA was a sale with contractual restrictions on use and transfer of the software. Mr. Vernor may thus invoke the first sale doctrine, and his resale of the AutoCAD packages is not a copyright violation.”

In copyright law, the first sale doctrine is codified in statute — allowing the owner of a particular copy to resell that copy even if the owner had contractually agreed not to do so. 

“[T]he owner of a particular copy or phonorecord lawfully made under this title … is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy or phonorecord.” 17 USC 109.

In patent law, the first sale doctrine – also known as patent exhaustion – has no statutory support. Rather, like the doctrine of equivalents, patent exhaustion is grounded in common law principles.  The Quanta case is fairly technical and could result in a narrow low-impact opinion. However, it is also quite possible that the Supreme Court will re-solidify the property concepts.  Expect a decision within the next few weeks.

Notes:

• Patry and InternetCases have more details on the Autodesk case.
• More on Quanta v. LGE.
• Comment on Chain of Title: M. Slonecker: “For the sake of factual accuracy, AutoDesk "sold" the software to CTA. At a later date CTA auctioned off its assets, and Mr. Vernor was the winning bidder for the software program discs. With copies in hand, Mr. Vernor placed the discs he purchased at the auction on sale at eBay. Apparently AutoDesk is not pleased with this state of affairs and has been engaged in a running battle with Mr. Vernor about his eBay activities.”