Tuesday, April 21, 2009

TransCore LP v. Electronic Transaction Consultants Corp.

Patent Exhaustion and Legal Estoppel
Previous Settlement Leaves Patent Owner “Exhausted

In June 2008, the Supreme Court decided Quanta Computer, Inc. v. LG Electronics and reaffirmed that the doctrine of patent exhaustion is alive and well and is fully applicable to method claims. (For a more thorough discussion on Quanta, see http://www.dorsey.com/eupdate_quanta_v_lg_electronics_inc_070108/). The Federal Circuit has now taken the opportunity to further bolster the patent exhaustion doctrine in the recently decided case of TransCore LP v. Electronic Transaction Consultants Corp., 2008-1430.

The facts of TransCore can be briefly summarized as follows. The patent owner, TransCore, was involved in a litigation in 2000 against Mark IV Industries. That action was resolved by a settlement agreement in which Mark IV paid TransCore $4.5M in exchange for an “unconditional” covenant not to sue under a denominated list of ten (10) U.S. Patents and the foreign counterparts thereof. After listing the specific patents within the covenant, the settlement agreement provided that “This Covenant Not To Sue shall not apply to any other patents issued as of the effective date of this Agreement or to be issued in the future.” The defendant, Electronic Transaction Consultants (ETC), purchased product from Mark IV and was sued for infringement of three patents that were previously asserted against Mark IV as well as one later issued patent, U.S. Patent No. 6,653,946 (“the ‘946 patent”). The district court granted summary judgment in favor of ETC finding that patent exhaustion precluded the assertion of the previously litigated patents and that TransCore was legally estopped from asserting the later issued ‘946 patent.

TransCore presents two significant issues. First, does a covenant not to sue that was provided as part of an earlier settlement agreement create an “authorized sale” that triggers patent exhaustion? Second, should the patent owner be estopped from asserting a later-issued patent, if that later-issued patent would limit the value of a right previously granted for valuable consideration?

With respect to the first issue, the Federal Circuit held that the fact that the right conveyed was described as a covenant not to sue, rather than a license grant, was a distinction without a difference in the context of the exhaustion analysis. By granting an unconditional covenant not to sue, the patent owner authorized the original defendant, Mark IV, to make, use and sell products under the asserted patents without threat of suit. This authorization was sufficient to exhaust TransCore’s rights against downstream purchasers, such as ETC. The comparative analysis between a covenant not to sue and a patent license provided in the TransCore opinion is worth reading, but the result, which favors substance over form, is not particularly controversial in view of Quanta.

The second issue is somewhat more problematic. The ‘946 patent was described by the Court as “a related patent that was pending before the Patent and Trademark Office but had not yet issued at the time of the TransCore-Mark IV settlement.” In the district court, “TransCore did not dispute that…the ‘946 patent was broader than, and necessary to practice, at least [one patent] that was included in the TransCore-Mark IV settlement agreement.” On this basis, the Federal Circuit held that “in order for Mark IV to obtain the benefit of its bargain with TransCore, it must be permitted to practice the ‘946 patent to the same extent it may practice [the patents listed in the settlement agreement].” As a result, TransCore was “legally estopped from asserting the ‘946 patent against Mark IV in derogation of the authorizations granted to Mark IV [under the settlement agreement].” Thus, the Corut held that Mark IV had an implied license to the later issued ‘946 patent and this implied license inured to the benefit of ETC.

Given the unambiguous language of the covenant not to sue, this result is somewhat troubling. The “benefit” Mark IV bargained for in the settlement agreement was TransCore’s forbearance of suit under a clearly defined set of patents. The parties certainly could have included language that would have embraced related patents, such as continuations, continuations-in-part and divisional applications, but chose not to do so. The parties also could have agreed to include pending applications, but chose not to do so. To the contrary, the parties expressly agreed to a covenant not to sue covering a closed-end list of U.S. and foreign patents and included language expressly excluding later issued patents. The parties valued this agreement at $4.5M.

The patent owner certainly received consideration for the covenant that was granted. However, it is entirely reasonable to believe that the amount of consideration was determined after a thoughtful analysis by both parties as to what was, and was not, included in the agreement. Was there a “derogation of rights” in this case that needed to be cured by imposing an implied license, or simply a party disappointed at the result of the limited bargain that it entered into? What is troubling here is that the Court’s holding in this case seems to result in a significant expansion of the rights that were actually conveyed, contrary to the express language of the agreement.

Can patent owners avoid this result in the future? In drafting language for license agreements and covenants not to sue, parties, especially patent owners, must take heed of the recent decisions in Quanta and TransCore, and use carefully crafted language in order to specifically define what is, and is not, authorized activity. Even then, there is clearly a risk that the doctrines of patent exhaustion or implied license may be imposed to limit the patent owners actions against third parties.

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