12 November 2020

Australian High Court Finds that Sale of a Patented Product Exhausts Patentee’s Rights

PrinterIn a significant judgment, the High Court of Australia has changed an aspect of patent law in Australia, ruling by a 4-3 majority that the first sale of a patented product exhausts the patentee’s exclusive rights in that product: Calidad Pty Ltd v Seiko Epson Corporation [2020] HCA 41.  For over a century, an alternative approach, based on an ‘implied licence’ theory, has applied.  While the distinction between these two approaches may not necessarily produce a different outcome in most practical circumstances, the implied licence approach has generated complications, and left Australian law out-of-step with some of our major trading partners, most notably the US and the European Union.  For reasons of simplification and harmonisation, therefore, the High Court’s ruling will be welcomed by many – myself included.

The decision of the High Court majority is also notable for the fact that the court has wasted no time in recognising the ‘objects clause’ in section 2A of the Patents Act 1990.  This clause, which sets out underlying purposes of the Act (in economic and social terms) was only enacted in February 2020, and this is literally the very first patent case that the High Court has decided since then.

The case involves printer ink cartridges, and in particular the refurbishment, refilling, and resale of cartridges, which are generally available at a lower price than cartridges sold by the original manufacturer.  Australian consumers will therefore be pleased to learn that the High Court has determined – in addition to the esoteric legal question of ‘exhaustion’ – that, in this case at least, the refilled cartridges do not infringe patent rights held by the original manufacturer, and can therefore be imported and sold in Australia.  I will discuss the ‘exhaustion’ aspect in this article, and save a review of the infringement decision for a separate post.

Background – Refurbishing Printer Ink Cartridges

Owners of printers are very familiar with the fact that manufacturers of these products have mostly adopted the so-called ‘razor-and-blades’ business model.  According to this model, an initial item – such as an inkjet printer – is sold at a low price (possibly below cost) in order to increase subsequent sales of consumable supplies – i.e. ink cartridges.  Unsurprisingly, an entire industry has evolved to supply cheaper ‘generic’ versions of these consumables, either by manufacturing copies or, more commonly, by refurbishing and refilling used cartridges.

Seiko manufactures and distributes Epson-branded printers and consumables, including ink cartridges that are the subject of its dispute with Calidad Pty Ltd (Calidad) and others.  Specifically, empty original Epson cartridges are obtained by Ninestar Image (Malaysia) SDN BHD (Ninestar), from various sources.  Ninestar modifies the cartridges so that they can be be refilled and re-used.  Calidad acquires the refilled cartridges from Ninestar and imports them into Australia for the purpose of sale to the public.

Original Epson cartridges include a memory chip, as part of an integrated circuit assembly, which can be read by compatible printers, and which keeps track of how much ink remains in the cartridge.  Once the ink falls below a threshold level, the memory chip reports – and continues to report – the cartridge as empty, so that the printer will prevent further printing using that cartridge.

As the majority explained, at [33], ‘[t]hird party suppliers obtain original Epson cartridges which are empty from a number of sources, including the original purchasers and recycling facilities, and supply them to Ninestar, which modifies them for re-use.’  The various modifications involved are described at [34], and include refilling the cartridge with ink, as well as either reprogramming or replacing the memory chip (or the entire integrated circuit assembly) so that it no longer indicates that the cartridge is empty.

Seiko’s patents, it should be noted, are not directed to these aspects of the structure and operation of the printer cartridges.  The patents actually address an electrical problem, namely that such cartridges generally require both a low-voltage supply (for the memory chips), and a high-voltage supply (for the sensors used to monitor the ink level).  The patents describe and claim a particular layout of electrical terminals designed to reduce the risk of shorting between the high- and low-voltage supplies that may result in damage to the cartridge, such as destruction of its memory chip.

At first instance before Justice Burley in the Federal Court of Australia (Seiko Epson Corporation v Calidad Pty Ltd [2017] FCA 1403), His Honour found that some – but not all – of the refilled cartridges imported and sold by Calidad infringed the Seiko patents.  On appeal to a Full Bench of the Federal Court (Calidad Pty Ltd v Seiko Epson Corporation [2019] FCAFC 115), Justices Greenwood, Jagot, and Yates found that all of the cartridges infringed the patents.

Two issues arose for consideration in the appeal to the High Court:

  1. whether an established doctrine of ‘implied licence’ accompanying the sale of a patented product should be replaced in Australia with an alternative doctrine of ‘exhaustion of rights’ – a matter in which the Federal Court had no discretion; and
  2. whether the Full Court was correct in finding that the refilled cartridges sold by Calidad infringed Seiko’s patents.

In This Article…

In this article, I will look only at the first of the two issues identified above, where the High Court has made the significant ruling, overturning a decision that has held for over a century, that Australian law recognises a doctrine of exhaustion – in common with the US and the European Union – rather than the implied licence approach that was ‘gifted’ to us by the Privy Council in 1911.

The Court has arrived at this decision by majority, with Chief Justice Kiefel along with Justices Bell and Keane issuing a joint judgment, with which Justice Gageler has agreed entirely.  Justices Nettle, Gordon and Edelman wrote in dissent, while Justice Gageler wrote separately in order to explain in additional detail his reasons for disagreement with the dissenting judgment.

Here I will discuss only the majority judgment.

I will review the decision in relation to infringement in a separate article.  I may also write separately on the dissent, once I have had a chance to read it in detail, along with Justice Gagaler’s rebuttal.

‘Implied Licence’ vs ‘Exhaustion’

There is an inherent tension between common law principles and patent law.  In particular, as the High Court majority confirmed at [12] (citing Griffith CJ in National Phonograph Co of Australia Ltd v Menck (1908) 7 CLR 481), it is ‘an elementary principle of the law of personal property’ that ‘the owner of chattels has an absolute right to use and dispose of them as he thinks fit, and that no restrictions can be imposed upon this right, except by positive law or by his own contract.’  On the other hand, patent law provides a patent owner with various exclusive rights in relation to products falling within the scope of their patent claims.  A product does not cease to be covered by a patent claim merely because it has been sold.  At the same time, however, a patent owner surely should not be able to assert ongoing rights over a patented product once ownership has been legally transferred to another party.

This tension could have been resolved by statute – the Patents Act could, for example, have included express provisions addressing the effect of a sale or other authorised transfer of a patented product – but that has not been done.  Instead, it has been left to the courts to determine how to resolve any conflict between patent law and the law of personal property as it arises.  Two distinct approaches have been developed:

  1. the doctrine of exhaustion of rights, under which the first sale of a patented product extinguishes the exclusive rights conferred by the patent in relation to that particular product; and
  2. the doctrine of implied licence, under which the patent rights in relation to the product continue following the first sale, while the new (and any subsequent) owner of the product effectively acquires a licence to do all of the things with it that they would normally be entitled to do under the law of personal property.

As the majority noted (at [17]), the US Supreme Court has adhered to the exhaustion doctrine for over 160 years, most recently in Impression Products, Inc. v Lexmark International, Inc. 137 S. Ct. 1523.  It is also the preferred approach of the Court of Justice of the European Union.

In Australia, however, the implied licence doctrine has been held to apply since the decision of the Privy Council in National Phonograph Co of Australia Ltd v Menck (1911) 12 CLR 15.  That was a decision on appeal from the High Court of Australia (National Phonograph Co of Australia Ltd v Menck (1908) 7 CLR 481) which had, in fact, favoured the exhaustion doctrine.  And while the High Court has not been bound by decisions of the Privy Council since at least the 1970s, it has not – until now – had a case come before it providing an opportunity to reconsider the application of the Privy Council Menck decision under Australian law.  It should be noted that at first instance before a single judge, and on appeal before a Full Bench of the Federal Court, it was agreed by all parties that the court was bound by Menck in the absence of any reconsideration by the High Court.

‘Implied Licence’ Out, ‘Exhaustion’ In

The majority of the High Court has now ruled that the Privy Council Menck decision is no longer good law in Australia, and that the doctrine of exhaustion of rights is to be preferred over the implied licence doctrine.  They described the difference between the two approaches (at [75]) as follows:

The exhaustion doctrine does not accept the premise that a patentee's rights of use with respect to the particular product survive its sale. That is the fundamental difference between the two doctrines. According to the exhaustion doctrine the purchaser of a patented product buys “’the use of the whole’ of the combination” , as would result from an ordinary sale. The exhaustion doctrine accepts that a patentee has special rights deriving from the patent which are given statutory effect, but holds that they are exhausted when the reward which is the object of those special rights is achieved by the patentee. The sale takes the product outside the scope of the patentee's monopoly rights. (Citation omitted.)

At [76] the majority observed that ‘[t]he exhaustion doctrine has the virtues of logic, simplicity and coherence with legal principle’, and that ‘[i]t is comprehensible and consistent with the fundamental principle of the common law respecting chattels and an owner's rights respecting their use.’  In contrast, they identified various disadvantages of the implied licence doctrine (at [77]), including:

  1. that it is ‘complicated in its operation and effects’;
  2. that it can only achieve a ‘partial alignment’ with fundamental laws relating to personal property, and even then ‘only when it is clear that no restrictions have been imposed at the point of first sale’;
  3. it may be difficult to identify whether restrictions were imposed upon a first sale, and whether subsequent owners then had notice of such restrictions; and
  4. it may be of limited applicability in the face of modern laws prohibiting various forms of anti-competitive conduct.

Furthermore, the implied licence is a legal fiction, in a time when a ‘preference for substance over form [does] not favour the preservation of legal fictions’.  It may ‘cause confusion in part because it combines a fictional licence with the possibility of real restrictions’, and thus ‘engenders uncertainty’ (at [78], [79]).

The majority therefore found, in conclusion (at [84]):

The matters which inform the adoption of a policy of the law as to the scope of the patent rights to sell and use a product, as they affect a patentee and owner of a chattel, point strongly to an acceptance of the exhaustion doctrine and away from the implied licence doctrine. Indeed there seems little to be said in favour of the latter unless consistency with the statute which grants the patent rights requires a different outcome.

Failed Arguments Against Change

Seiko made a number of submissions against a change from a doctrine of implied licence to one of exhaustion of rights.  Having been successful before the Full Bench of the Federal Court, it presumably felt that its position was favoured by the existing approach.  These, and other factors that might favour maintaining the status quo, were rejected by the majority of the High Court.

  1. The majority considered the compatibility of the exhaustion doctrine with the Patents Act 1990 (at [85]-[93]), and determined that there is no incompatibility, and that there is no basis to assume that the Parliament had assumed that a doctrine of implied licence, rather than exhaustion, applies in Australia.
  2. Seiko’s arguments that specific provisions of the Act (including some now repealed) relating to compulsory licensing and prohibiting certain typing contacts, might lead to a different conclusion, were rejected (at [94]-[98]).
  3. Seiko also pointed to extrinsic materials, including the 1984 report of the Industrial Property Advisory Committee (IPAC), Patents, Innovation and Competition in Australia [PDF, 1.5MB], and the Explanatory Memorandum to the Patents Bill 1990, as evidence of an expectation that the position established by Menck (Privy Council) was intended to continue to apply under the 1990 Act.  The majority disagreed, finding (at [102]) that the extrinsic material ‘leave the adoption of either doctrine open, presumably to the courts.’
  4. Seiko further unsuccessfully submitted – without supporting authority, and in contradiction with equivalent provisions in US patent law – that the exhaustion doctrine is inconsistent with provisions of the Patents Act providing that the exclusive rights conferred by a patent are themselves personal property.  This, of course, is an entirely separate issue to whether or not the rights of the patentee continue to apply to a particular product once it is sold (at [105]).
  5. Finally, the majority considered the inconvenience that might be caused by a change in the law after more than a century during which the Privy Council Menck decision has been followed.  The reality, however, is that cases involving the implied licence doctrine have been few and far between.  Furthermore, as the majority noted (at [109]), ‘neither principle nor authority supports the proposition that this Court should persist with an unworkable doctrine as to patent rights which cannot be said to be required by the statute which grants them’ and (at [110]), ‘[c]ontinued adherence to the implied licence doctrine is an unjustifiable gloss on the statutory language that confers monopoly rights on a patentee.’

Conclusion – A Major Change, with Policy in Play

The High Court has changed the law in Australia.  Where, for over a century, the implied licence doctrine held sway, the principle of exhaustion of rights upon sale of a patented product now firmly applies.  This brings Australian law into line with the US and with the European Union (and probably others, although I have not researched the position elsewhere).

Policy considerations played no small part in this decision.  It is particularly notable that the Court made reference to the new ‘objects clause’ in section 2A of the Patents Act 1990, which only recently came into effect, on 27 February 2020, and which states that:

The object of this Act is to provide a patent system in Australia that promotes economic wellbeing through technological innovation and the transfer and dissemination of technology. In doing so, the patent system balances over time the interests of producers, owners and users of technology and the public.

The majority observed (at [92]) that:

… one component of that object is to ensure the efficiency of the market economy. …. Another is to encourage innovation. This latter objective is achieved by ensuring that a patentee is rewarded for the often considerable efforts and expense which have contributed to a useful invention. That reward is obtained on the sale of a product on terms for which the patentee has negotiated. There is nothing in the Patents Act 1990 to suggest that a patentee is to be rewarded more than once.

In my view, this is correct, and the Court is simply giving effect to the (likely) intentions of Parliament.  Some will see it as common sense prevailing.  Still others, however, may regard it as an overt example of policy-making from the bench, or a form of judicial activism.  It all depends on your perspective!


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