Stop patent exhaustion

Editor's Note: As globalization intensifies, companies from different countries are increasingly connected because of the different roles they play in an industry chain. But at the same time patent litigation risks also rise. For example many Chinese companies sell components to manufacturers or assemblers in China, which then incorporate the components into machines that are exported to the United States. By exporting the machine containing a patent infringing component, the machine manufacturer or assembler would be liable for infringement.

Nowadays many companies increasingly look to legal tools, such as contract indemnification, to shift liability patent infringement. Brian Kacedon, an attorney at US law firm Finnegan, and Connie Chang, a former attorney at the firm, talk about tools for managing risks associated with such sales contracts or licenses in this article.

China Business Weekly ran the first part of the article in the last issue. Below is the final part. The views expressed here are the authors' own.

Another situation of concern involves component manufacturers who receive licenses, but the licenses require the component manufacturer to place conditions on the sale of the licensed products or components.

For example, the patent owner could condition the license on the licensee's agreement to sell components only to entities that have already obtained a license from the patent owner.

The goal of such an arrangement is typically to try to avoid the doctrine of "patent exhaustion", which provides that the sale of a licensed product by an authorized licensee exhausts the patent owners right to control that component.

For example, ordinarily, if a component manufacturer were licensed to sell certain components, a patent owner could not enforce its patent against a subsequent purchaser of that component. But under an arrangement such as that described above requiring the licensee to condition the sale of components on the purchaser being licensed, a sale of a component to an unlicensed entity would not exhaust the rights of the patent owner.

Historically, in the United States, such conditions would ordinarily have been sufficient to prevent patent exhaustion as described above. Recent developments in US law, however, have cast doubt on the extent to which patent owners can contract around patent exhaustion.

For the time being, manufacturers who purchase components from companies claiming to have the appropriate licenses should carefully ascertain whether the licensee has attempted to condition the sale of the product in a manner that would still allow the patent owner to enforce the patents against downstream customers.

Examples of such conditions may include a "Single Use Only" label on a patented component, specifying that by opening the package or using the component, the downstream user confirms acceptance of the device's "Single Use Only" restriction and acknowledges that it is unlawful to resell, reuse or remanufacture the component without getting a license.

Another example is the case of an owner of both foreign and US patents which prints on every package of the patented component sold in a foreign country an express notice stating that the component should not be imported or re-sold within the United States without first getting a US license.

A third example is providing notice that the "component is to be used in machines already licensed for use" provided in conjunction with sale of patented component, which has been deemed effective to avoid an implied license to use the components in a machine covered by a patent owned by the component maker.

Other contractual considerations

When it comes to liabilities concerning potential intellectual property infringement, parties can be very creative in negotiating the terms of the agreement.

Of course, terms also depend on respective bargaining power. There are several considerations that downstream machine manufactures or assemblers should also consider in negotiating contracts with their counterparts. The flip side of these terms is also available for the component makers:

Make sure that indemnification is not the sole remedy;

Make sure that suppliers do not cap the amount of damages at the amount of sales or liquidating damages;

Ensure that the representation of non-infringement includes all the major markets for the machine manufacturers and is not limited to only certain types of claims (eg limiting the representation to apparatus claims only, not method claims);

Ensure that the representation of non-infringement includes all known and unknown rights;

Increase the scope of the indemnity or representations beyond federal patent, copyright, or trademark law;

Require the component maker to obtain intellectual property liability insurance, as many component makers are financially incapable of defending their downstream customers in the event of infringement. Intellectual property liability insurance provides the funds to fight the legal battles when machine manufacturers or assemblers are accused of infringement. In the case of the standard indemnification clause, the liability insurance will put in place the funding mechanism to cover the indemnification liability; and

Determine who has control over the litigation. Note that usually, an indemnitor (eg a component maker) will request to have sole control over the lawsuit or settlement negotiation. An indemnitee might find this lack of control unappealing and unacceptable, especially when the indemnitee prefers to settle quickly and the component maker would like to litigate to the bitter end. However, it is important that an indemnitee (eg a machine manufacturer or assembler) should have the choice to be represented by its own legal counsel throughout the entire process.

Every company today has many business contracts that are pivotal to their operations. When companies fail to understand the contract terms, manage the associated risks and allocate the risks and results of any potential infringement by their counterparts, they can find themselves exposed to potential loss of revenue and excessive costs.

In particular, because litigating infringement lawsuits can be very time-consuming, tremendously costly and of great uncertainty, Chinese companies should consider protecting themselves by insisting on an indemnification provision in the sales contracts.

Remember, preventions is always better than cure.

(China Daily 11/10/2008 page9)