Doctrine of Exhaustion as Applied to Patent Rights

August 8, 2005
Harakenzo World Patent & Trademark
Brendan CHEONG

Introduction
The doctrine of exhaustion of rights in patent law concerns the rights of a patent holder and to what extent the rights of the patent holder extend over his patented invention after the patent holder has made a first sale of his patented invention. [1] Specifically, the doctrine provides that the patent holder has an exclusive right to control the first sale or use of his patented invention but once such a first sale or use has occurred, and the holder has recouped the financial reward due to him for his patented invention, his right to control the future sale or use of the patented invention so sold is exhausted. [2]

The basis for the doctrine of exhaustion of rights in patent law can be linked to the fundamental purposes of patents and also to the downstream flow of rights from a seller to a purchaser.

One of the fundamental purposes of patents is to encourage the disclosure and innovation of new, useful and non-obvious inventions [3] and to promote the progress of science [4] by providing owners of such inventions with a limited monopoly on the financial exploitation and marketing of their inventions, so as to secure financial rewards for their inventions [5] .
With this purpose of patents in mind, it has been reasoned that since a patent holder has control of the first sale of his invention, the patent holder has the opportunity to receive full consideration for his invention from the sale and will hence exhaust his rights in the future control of the invention for which consideration was received. [6]

Further, it has been reasoned that sale of goods is based on the premise that the purchaser acquires everything the seller has in the goods, unless the terms of the sale were explicitly restricted. [7] It has been explained that when an owner sells a good without any reservation respecting its use, or to whom the good may pass to, the purchaser acquires the same rights thereto as had the vendor, and subsequent purchasers acquire the rights of the sellers and may do with the good in any way the first purchaser may have lawfully done had he not sold it. [8]

From the above, it can therefore be readily understood that in controlling the first sale of his invention, the patent holder has had the opportunity to fairly be rewarded for his invention, and also, unless explicitly limited, has passed on all rights he has in his invention to the purchaser, thereby exhausting his rights in any future control of his patented invention.

As simple as the concept of exhaustion may seem from the above, there is, however, much debate on how the doctrine of exhaustion of rights is to be interpreted in the international context where a patented invention may cross a plurality of jurisdictions [9] .
The debate, revolving mainly around what constitutes a first sale, involves disagreement to such an extent that even the TRIPS Agreement, insofar as how the doctrine of exhaustion is to be interpreted, contains only a statement [10] to the effect that no portion of the TRIPS Agreement is to be used to address this issue [11] .

Exhaustion Today
The lack of consensus provided by the TRIPS Agreement effectively allows jurisdictions to interpret as they please the doctrine of exhaustion of rights [12] , resulting in several variants of the doctrine, namely International Exhaustion, National Exhaustion, Regional Exhaustion and Modified International Exhaustion.

The International Exhaustion interpretation of the doctrine of exhaustion provides that a first sale of the patented invention by the patent owner in any jurisdiction, exhausts the patent owner's rights to the patented invention in all other jurisdictions. [13] Hence, once sold, the patented invention may move freely anywhere in the worldwide market. [14]

The Domestic Exhaustion interpretation of the doctrine mandates that the patent owner's rights in his patented invention are deemed to be exhausted only by a first sale by the patent owner in the same jurisdiction as his patent rights [15] .
By this interpretation of the doctrine of exhaustion, a patent owner's rights in a first jurisdiction are not affected by a sale by the patent owner of his invention in another jurisdiction. [16]

The Regional Exhaustion interpretation requires first a collection of jurisdictions (a region) which have agreed to abide by community laws with regards to specific issues, the most definitive example of which is the European Union. According to this interpretation of the doctrine, a patent owner’s rights are exhausted throughout the region if the first sale was made in any one of the jurisdictions comprising the region, but are not exhausted by a first sale made in a jurisdiction outside of the region. [17]

Lastly, the Modified International Exhaustion interpretation of the doctrine is in almost all respect identical to
the International Exhaustion interpretation except for the allowance of the restriction of the extent of exhaustion through explicit contractual terms. [18]

The Implications of Exhaustion
The practical implications of the doctrine of exhaustion of rights are felt most keenly in the area of parallel imports. [19] Parallel, or grey, imports are genuine goods, which are sold through unauthorized channels in direct competition with authorized distributors. [20] An example of a parallel import would be that of an invention which enjoys patent protection in a first country, which was sold by the patent holder and subsequently legitimately purchased in a second country, and which was then exported from the second country by the purchaser back to the first country usually at a lower price than that offered by the patent holder or their authorized distributor.

The critical issue in such a scenario, which the TRIPS Agreement failed to address, and which different jurisdictions have interpreted to their best advantage, is whether the patent holder’s right in the first country was exhausted by his sale of the patented invention in the second country, or more to the point, whether an importer in the first country who purchases the patented invention not from the patent owner but instead from the exporter in the second country infringes the patent owner’s rights. Whether the importer infringers the patent owner’s rights depends entirely on the interpretation of the doctrine of exhaustion adopted by the first country.

International Exhaustion interpretation – Under this interpretation, the importer would not be found to be infringing since it would be held that the rights of the patent holder were exhausted with his sale of his invention in the second country. National Exhaustion interpretation – Under this interpretation, the importer would be found to be infringing the patent right of the patent holder in the first country since exhaustion of the patent holder's right in the first country can only be effected by a sale of the patented invention by the patent holder in the first country and not elsewhere. Regional Exhaustion interpretation – Under this interpretation, it would depend on whether the first and second country belong to the same economic region. Non-infringement would be found if the two countries did belong to the same economic region, and infringement would be found if otherwise. Modified International Exhaustion – Under this interpretation, infringement by the import in the first country would only be found if the sale of the invention by the patent owner to the purchaser/exporter in the second country was limited through contractual terms which prevented exporting of the patented invention back into the first country.

The National Exhaustion interpretation, and to some extent the Regional Exhaustion interpretation, provide patent holders with an efficient tool for separating markets [21] and to thereby maximise financial returns from each market. [22] The National Exhaustion interpretation is therefore understandably preferred by patent owners, and countries which are net producers of patent rights. The International Exhaustion interpretations generally favour consumers who, through cheaper parallel imports, are able to enjoy lower prices.

International Exhaustion vs. National Exhaustion
The arguments for National Exhaustion over International Exhaustion emphasize the importance of properly rewarding patent owners, for the better of all concerned. Proponents of National Exhaustion argue that permitting market segmentation allows patent owners to maximize their returns on their invention, thereby providing incentives to the further creation of intellectual products. [23]

A more convincing argument argues that allowing market segmentation allows inventions to be made available in developing markets at lower and locally more affordable prices, since the risk of the lower priced goods finding their way to more premium markets is eliminated. [24] The same argument viewed from a different angle suggests that preventing market segmentation could result in developing markets having limited to no access to often state of the art technology, or at best access to such technology at prices well beyond the means of most [25] , since owners of patented inventions would be wary of providing their goods for sale at a reasonable price for the developing markets or at all for fear of subsequent exports of the cheaply priced products from the developing markets to premium markets.

A further argument from a legal standpoint points out that protection of intellectual property has traditionally been a matter of national sovereignty, [26] and a National Exhaustion interpretation avoids unnecessary intrusion into this tradition of national sovereignty. [27]

Yet another argument concerns the haplessness of the patent holder in controlling the first sale when compulsory
licensing [28] as laid out by Article 31 of TRIPS is involved [29] .
Where compulsory licensing is involved, the patent owner may be compelled to license his rights to a third party with royalties determined by the government and not the patent owner. [30]

It has been described [31] a plausible scenario where one jurisdiction authorizes a compulsory licensing of a patent to a third party, with royalties to be paid by the third party to the patent holder being decided by the nation’s government, followed subsequently by the export of the patented invention to a market in a second jurisdiction at a significantly lower price. Assuming the second jurisdiction adopts an International Exhaustion interpretation of the doctrine of exhaustion, goods from the first jurisdiction may legally enter the second jurisdiction despite the patent owner holding patent rights in the second jurisdiction. Such a situation clearly disadvantages the patent holder and takes away any incentive for the patent holder to disclose his invention to the public and further innovate.

Though it has been suggested that a sale through compulsory licensing should not be considered a first sale for the
purposes of determining exhaustion [32] , such a scenario has not as yet been taken into consideration and a first sale, whether or not through compulsory licensing, presently under the International
Exhaustion interpretation nonetheless exhausts the patent owner’s rights in the second jurisdiction. [33]

On the other hand, the arguments for International
Exhaustion emphasize the original purpose of patent law, the rights passed from seller to purchasers, and also the ideals of free trade and the spirit of the TRIPS Agreement.

The reasoning advancing International
Exhaustion based on the purpose of patent law hinges on the notion that the main purpose of patent law is to promote the progress of science through disclosure by granting to the inventor a limited monopoly, the exercise of which will enable him to secure financial rewards for his invention [34] .
By this exercise of limited monopoly, the inventor is entitled to receive a full consideration for the sale of his invention after which his rights in the inventions will be exhausted. [35]

Along such lines, it is argued by proponents of International Exhaustion that the mere fact that national borders are crossed does not constitute a sound reason why a second opportunity for compensation of the disclosure should be allowed. [36] The patent owner is compensated for the public disclosure of his invention when he first sells the patented product, and should not be allowed to reap a double profit from the patented products once they are sold by him. [37] Awarding an inventor additional royalties would exceed the compensation intended by the patent system and give the owner double compensation. [38]

Further, it was reasoned that when patented products are sold in a foreign country, it is naturally expected that such products will be imported back locally and hence, when the patent owner sells its patented products in a foreign country without any reservation, the patent owner should be presumed to have implicitly granted to the purchaser or subsequent acquirer, a license to control the product. [39]

From an idealistic footing, it has been argued that the International Exhaustion interpretation is more in line with the purpose of the TRIPS Agreement as stated in its preamble, namely to promote unimpeded free trade in intellectual products, to protect ownership interests in intellectual products, and to avoid having such protection become a barrier to trade in related goods and services. [40] In this regard, has been submitted that an International Exhaustion interpretation protects local consumers against artificially high prices through increased domestic competition, and therefore effects the market efficiencies envisioned by the free-trade principles of the WTO. [41] Additinally, it is suggested that the above scenario encourages exports of low-cost production, thereby fostering efficient international resource allocation and growth through increased production investment. [42]

The World in Brief
With the inability of the TRIPS Agreement to reach an agreeable resolution allowing jurisdictions to interpret the doctrine of exhaustion using whichever of the above arguments best suits them, patent owners are presented with a fragmented global market with no clear separation between the markets adopting a National Exhaustion interpretation and those adopting a International Exhaustion interpretation. [43] Though it has been generalised that developed economies favour National
Exhaustion and developing countries favour International Exhaustion [44] , such a generalisation is not altogether accurate in its characterisation.

A brief look at three influential world economies alone reveals a significant disparity in their interpretations of the doctrine of exhaustion.

U.S.A.
The United States of America subscribes to the National Exhaustion interpretation of the doctrine of exhaustion. [45] The definitive case to date on this issue being the United State’s Federal Circuit Court of Appeals’ decision in Jazz Photo Corporation v. Int’l Trade Comm. [46] It is interesting to note, however, that the Federal Circuit in Jazz Photo failed to offer any convincing rationale for adopting the National Exhaustion interpretation of the doctrine of exhaustion. [47]

E.U.
The European Union adopts the Regional
Exhaustion interpretation of the doctrine, wherein patent exhaustion has been aggressively applied with respect to products sold in the E.U. [48] , but not to products originating from outside the E.U. [49] The European Court of Justice’s decisions in Centrafarm BV v. Sterling Drug Incorporated [50] and Silhouette Internat’l Schmied GmbH & Co. KG v. Hartlauer Handelsgesellschaft Gmbh [51] respectively illustrate this discriminatory application of the doctrine.

Japan
Japan controversially adopts the Modified
International Exhaustion interpretation of the doctrine [52] , where Japanese patent holders have to specifically restrict the initial sale of their products if they wish to prevent subsequent parallel importation of their inventions into Japan. The definitive decision on this issue is the Supreme Court of Japan’s affirmation of the Tokyo High Court’s decision in BBS Kraftfahrzeugtechnik AG v. Racimex Japan KK et al. [53] asserting International Exhaustion, and the Osaka District Court’s decision in Brunswick Corp. v. Orion Kogyo KK, [54] illustrating explicit restrictions during sale limiting the subsequent sale and use by the purchaser.

Unlike the U.S. Federal Circuit Court of Appeal's decision ruling for National Exhaustion which lacked any convincing rationale, the Japanese Supreme Court in their decision supporting an International Exhaustion interpretation provided a reasoned approach to their decision. It was stated by the Supreme Court that:

(i)protection of inventions and public interest must be balanced;
(ii)sale of goods is based on the premise that the purchaser of goods acquires everything the seller has in the goods, and free movement of goods will be hampered if the patent owner’s license is required every time the patented products are resold; and
(iii)the patent owner is compensated for the public disclosure of his invention when he first sells the patented products and he should not be allowed to make a double profit from the patented products once they are sold by him . [55]

Such a reasoned approach arguably provides the International Exhaustion interpretation with a more convincing position than the United State’s silence on their ruling for National Exhaustion.

Conclusion
How the doctrine of exhaustion of rights in patent law is interpreted determines the extent of a patent owner’s rights in controlling the sale and use of his patented invention, and more importantly, how and when his rights will be exhausted. The doctrine hence significantly influences a patent owner’s ability to segregate markets in which his invention is being sold and hence the returns he could expect to receive from the sale of this patented invention.

The lack of consensus in the interpretations by major economic entities on the issue of exhaustion pose a significant point of consideration to patent holders. Where and for how much patent holders part with their patent rights are critical points to consider if the patent holder is to receive a satisfactory reward for his efforts in and disclosure of his invention.

With the present lack of consensus on this issue of exhaustion, it would seem prudent for patent owners to assume a global adoption of the Modified International Exhaustion interpretation, and to control their first sale accordingly. Not obtaining patent protection in jurisdictions adopting an International Exhaustion interpretation, as has been suggested by one author [56] , does not appear to be a prudent decision as even in jurisdictions adopting
International Exhaustion, patent rights still exclude others from manufacturing, selling, and using products similar to the patented product but not originally made available for sale by the patent owner.

Restrictions on subsequent sales through contractual limitations on the face is a very flexible and tidy solution to the issue of exhaustion, and simultaneously compliments both the spirit of the free trade ideals embodied by the TRIPS Agreement and the concept of providing incentive to inventors through limited monopolies of their patented inventions.
However, the allowance of compulsory licensing as presently set forth by TRIPS Article 31 makes such a solution not without its risks, albeit in only a small number of scenarios, though arguably in scenarios often concerning patented inventions of the highest monetary value, such as pharmaceuticals.

The practical implications of the doctrine of exhaustion, without consensus among jurisdictions, is complicated and often unclear to the patent holder prior to a first sale. It is felt that consensus is important and necessary, and should be effected through international agreements such as TRIPS.

[1] Daniel Erlikham, "Jazz Photo and the Doctrine of Patent Exhaustion: Implications to TRIPs and International Harmonization of Patent Protection"(Winter 2003) 25 Hastings Communications and Entertainment Law Journal 307 at 309
[2] ibid.
[3] ibid.
[4] Jonathan A. Harris, "Taking Control of The Implied License Defense To Process Patent Infringement", (November 1999) Intellectual Property Today
[5] Erlikham supra.
[6] E. Robert Yoches, "Licensing Patents for Software and Computer Technology", (November 1994) Intellectual Property Today
[7] Teruo Doi, "The Territoriality Principle of Patent Protection and Conflict of Laws: A Review of the Japanese Court Decisions", (January 2003) 26 Fordham International Law Journal 377, at 390
[8] Tait R. Swanson, "Combating Gray Market Goods in a Global Market: Comparative Analysis of Intellectual Property Laws and Recommended Strategies, (Winter 2000) 22 Houston Journal of International Law 327, at 343
[9] Vincent Chiappetta, "The Desirability of Agreeing to Disagree: The WTO, TRIPS, International IPR Exhaustion and a few other things", (Spring 2000) 21 Michigan Journal of International Law 333, at 334
[10] TRIPS – Article 6 "For the purpose of dispute settlement under this Agreement, subject to the provisions of Articles 3 and 4, nothing in this Agreement shall be used to address the issue of the exhaustion of intellectual property rights."
[11] Erlikham, supra at 315
[12] John H. Barton, "Global Trade Issues in the New Millennium: The Economics of Trips: International Trade in Information-Intensive Products" 33 George Washington International Law Review 473, at 493
[13] Ako Shimada Williams, "International Exhaustion of Patent Rights Doctrine: Is Japan’s Move a Step Forward or Back from the Current Harmonization Effort", (Fall 1998) 7 Detroit Journal of International Law & Practice 327, at 332
[14] Chiappeta, supra at 341.
[15] Ibid.
[16] Williams, supra at 331
[17] Swanson, supra at 343-344
[18] Erlikhman, supra, at 310
[19] Swanson, supra at 330
[20] Swanson, supra at 328
[21] Chiappetta, supra at 335
[22] Chiappetta, supra at 358
[23] Ibid.
[24] Chiappetta, supra at 357-358
[25] Williams, supra at 352
[26] Chiappetta, supra at 343
[27] Chiappetta, supra at 344
[28] Erlikham, supra at 320
[29] TRIPS Article 31 – "Where the law of a Member allows for other use of the subject matter of a patent without the authorization of the right holder, including use by the government or third parties authorized by the government, the following provisions shall be respected: (h) the right holder shall be paid adequate remuneration in the circumstances of each case, taking into account the economic value of the authorization;c(j) any decision relating to the remuneration provided in respect of such use shall be subject to judicial review or other independent review by a distinct higher authority in that Member;"
[30] Sarah, Büchner, TRALAC (Trade Law Centre for Southern Africa), http://www.tralac.org/scripts/content.php?id=19 (as on June 2004)
[31] Erlikham, supra at 320
[32] Chiappetta, supra at 375
[33] Erlikham, supra at 320-321
[34] Harris, supra
[35] Yoches, supra.
[36] Tokyo High Court Decision, Jap Auto Products Kabushiki kaishi and Another v. BBS Kraftfahrzeugtechnik AG; BBS v. Rashimex Japan Co. et al., (March 23, 1995) Hanrei Jino 3 (No. 1524), cited by Erlikham supra, at 326
[37] Supreme Court of Japan, BBS Kraftfahrzeugtechnik AG v. Racimex Japan KK et al., (July 1, 1997) 51 Minshu 299, 1612 Hanrei Jiho 3 (Sup. Ct. 3 rd Petty Bench), cited by Doi supra, at 390
[38] Harris, supra.
[39] Ibid.
[40] Chiappetta, supra at 343
[41] Chiappetta, supra at 357
[42] Ibid.
[43] Chiappetta, supra at 347-355
[44] Chiappetta, supra at 347; Erlikham, supra at 310
[45] Erlikham, supra at 309
[46] U.S. Federal Circuit Court of Appeals, Jazz Photo Corporation v. Int’l Trade Comm., (2001) 264 F.3d 1094
[47] Erlikham, supra at 324
[48] Erlikham, supra at 329
[49] Erlikham, supra at 330
[50] Case 15/74, 1974 E.C.R. 1147.
[51] Case 3-355/96, 1998 E.C.R. I-4799
[52] Erlikham, supra at 327
[53] BBS Kraftfahrzeugtechnik AG v. Racimex Japan KK et al., supra
[54] Brunswick Corp. v. Orion Kogyo KK, (June 9, 1969) 1 Mutai Saishu 160 (Osaka Dist. Ct.)
[55] Erlikham, supra at 390, citing BBS Kraftfahrzeugtechnik AG v. Racimex Japan KK et al.
[56] Williams, supra at 351