Retroactive Authorization of Sales and the Doctrine of Patent Exhaustion
Many of us are familiar with the old adage “forgive and forget,” but when it comes to settlement agreements and the doctrine of patent exhaustion, the trend seems to be “forgive and go after the downstream entities.” Recently courts have embraced the idea that sales cannot be retroactively authorized by agreement (for example by release, license, covenant not to sue, etc.) for purposes of patent exhaustion. The United States District Court for the Southern District of New York recently denied a motion for summary judgement in Jonathan Berall, M.D., M.P.H. v. Teleflex Medical Inc., et al that addressed this issue.1 The decision rejected an argument that patent exhaustion applied to patent claims asserted against a distributor of an accused product when a settlement agreement had released the manufacturer of that product. The doctrine of patent exhaustion provides that “the initial authorized sale of a patented item terminates provides all patent rights to that item.”2 In Berall, the court reviewed the settlement agreement between the patent owner and manufacturer and found that, at the time the sales to the distributor were made, the sales were not authorized and the doctrine of patent exhaustion did not apply.
Dr. Berall owned a patent directed towards a “laryngoscope for use in trachea intubation.”3 In a lawsuit filed in 2010, Dr. Berall accused Aircraft Medical Ltd (“Aircraft”) of manufacturing allegedly infringing laryngoscopes, and accused LMA of distributing and selling those allegedly infringing laryngoscopes. Dr. Berall eventually entered into a settlement agreement with Aircraft. The language of the agreement included the following release from liability:
Berall releases Aircraft and its Affiliates from any claim or demand, whether now known or unknown, arising out of or related to (i) infringement of the ’178 patent; (ii) the claims and counterclaims asserted in, and the conduct of, the Litigation; (iii) any acts and
conduct prior to the Effective Date of this Agreement that would have been released under this Agreement if performed after the Effective Date; and (iv) the conduct of settlement negotiations (except for representations or obligations expressly included in this Agreement).4
Following the settlement, the accused manufacturer (Aircraft) was dismissed from the case, but the distributor (LMA) was not. Teleflex was substituted as a party in place of LMA (in December 2013 LMA merged into Teleflex and ceased to exist). Teleflex then filed a motion to dismiss arguing that the settlement agreement between Dr. Berall and Aircraft retroactively constituted “an authorization of Aircraft’s past sales of the [accused product] because it [was] unconditional and [did] not exclude sales to any downstream distributor or user.” Thus, Teleflex argued that any patent rights Dr. Berall may have had in sales of the accused laryngoscopes were exhausted by the initial sale from Aircraft to LMA, and that under TransCore v. Electric Transaction, Berall could not “seek further recovery with respect to [the] released products downstream from Aircraft.”5
In distinguishing the TransCore decision, the court explained that “[TransCore] instructs that the focus should be on the substance of the Agreement rather than its form. In other words, the critical question asks what the [a]greement authorizes, not whether it ‘is framed in terms of a ‘covenant not to sue’ or a ‘license’’ or a ‘release.’”6 However, the court pointed out that “unlike in TransCore, LMA’s sales were made before the settlement agreement between Dr. Berall and Aircraft was effectuated.” The court found that “[b]ecause the Agreement [did] not retroactively authorize Aircraft’s past sales, patent exhaustion  [did] not protect LMA’s pre-Agreement downstream sales of the [accused product]” (emphasis added).7 The Court sought to buttress its distinguishing of TransCore by relying on two cases, Realtime Data LLC v. EchoStar Corporation (E.D. Tex.)8 and Sunoco Partners Marketing & Terminals L.P. v. U.S. Venture, Inc. (S.D. Ill.).9 The Realtime Data case held that “[f]or exhaustion to apply, a sale must be authorized at the time of sale—subsequent events cannot retroactively authorize an earlier sale.” The Sunoco case stated that “[t]he conclusion that a subsequent purchase of the patent itself cannot retroactively authorize an earlier sale of a patented item reinforces the court’s determination that a subsequent covenant not to sue cannot do so either.” Both of these cases base their conclusion on an interpretation of Honeywell International, Inc. v. United States.10 In that case the patent owner’s acquisition of the patent through merger did not retroactively authorize its own sales of the infringing product to the government. Thus, the patent owner was free to seek recovery based on the government’s use of the infringing product.
Courts are not unanimous on this issue. One court applying TransCore has found that sales can be retroactively authorized for the purposes of patent exhaustion. In PSN Ill., LLC v. Abbott Laboratories11, the defendant argued that by providing an unconditional release for prior use of the patent at issue to each of the third parties, the patent owner had authorized the sales made by those third parties—including sales to the defendant—and therefore the doctrine of patent exhaustion precluded infringement. The PSN court analyzed whether the settlement agreements between the patent owner and the third parties placed any limitation on the defendant’s prior use of the patent and therefore whether the release was conditional or unconditional.12 The court found that with respect to past infringement, the settlement agreements were unconditional because they “do not limit the release to [the third party’s] manufacture or use of the [patented technology] and so must necessarily release it from any sale of the [patented technology].”13 The court thus reasoned that the patent owner retroactively authorized the sale of the patented technology from the third party to the defendant, and that the patent owners’ rights in the patented technology terminated when the third party sold the technology to the defendant. The court explained that this result was consistent with the purpose of the doctrine of patent exhaustion, because the patent owner had the opportunity to bargain for and receive the full value of its patent through its settlement agreement with the third parties who sold the patented technology to the defendant. It would be unfair, reasoned the PSN court, to allow the patent owner to seek a double recovery by going after the downstream purchasers.14 The court in Berall also analyzed the PSN decision, but declined to apply PSN because it did not discuss that the sales in TransCore postdated the covenant not to sue and did not “reckon with (or even cite to) Honeywell.”15
Similar public policy considerations to those in PSN were at play in Berall. Dr. Berall was in the best position to bargain for the full value of the patent during his settlement negotiation with Aircraft. In order to reduce the burden on the courts and minimize judicial expense, the patent system should encourage patent owners to negotiate with entities as far upstream as possible. Furthermore, the plain language of the release in the settlement agreement between Aircraft and Dr. Berall specifically considered Aircraft’s past infringement: “Berall releases Aircraft and its Affiliates from any claim or demand, whether now known or unknown, arising out of or related to (i) infringement of the ’178 patent…” (emphasis added).16 If retroactive authorization of past sales is possible, the plain language of the settle agreement between Aircraft and Dr. Berall appears to do so. It could be argued that Dr. Berall should not be allowed to recover twice for alleged infringement related to the same product.
Practitioners should be aware that, while not settled law, the trend seems to be towards not allowing retroactive authorization of sales and should consider structuring their settlement agreements involving a release from liability accordingly. For example, practitioners can consider whether or not they intend to include downstream distributors/buyers in the release and if so, include them explicitly.
1 Jonathan Berall, M.D., M.P.H. v. Teleflex Medical Inc., et al, 10-CV-5777, (S.D.N.Y Sept. 13,2021).
2 Quanta Comput., Inc. v. LG Elecs., Inc., 553 U.S. 617, 625 (2008).
3 Berall at 2.
6 Berall at 7, n.4.
7 Id. at 8.
8 Realtime Data LLC v. EchoStar Corp., No. 6:17-CV-00084-JDL, 2018 WL 10466828, (E.D. Tex. Dec. 6, 2018)
9 Sunoco Partners Mktg. & Terminals L.P. v. U.S. Venture, Inc., No. 15 C 8178, 2017 WL 4283946, (N.D. Ill. Sept. 27, 2017)
10 Honeywell Int’l, Inc. v. United States, 609 F.3d 1292, 1304 (Fed. Cir. 2010)
11 PSN Ill., LLC v. Abbott Lab’ys, No. 09 C 5879, 2011 WL 4442825, (N.D. Ill. Sept. 20, 2011)
12 Id. at 14.
13 This paragraph discusses the arguments with respect to one of the third parties, but similar arguments applied to the other third parties.
15 Berall at 9, nt. 7.
16 Berall at 3.
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