On April 8, 2009, the U.S. Court of Appeals for the Federal Circuit issued a decision in TransCore, LP v. Electronic Transaction Consultants Corp. (No. 2008-1430) that will have a significant impact on how agreements relating to patents are interpreted. Patent owners must consider this decision when entering into agreements affecting their patent rights. The Federal Circuit held that (i) an unconditional covenant not to sue has the same effect as an unconditional license for purposes of patent exhaustion, and (ii) a covenant not to sue conveys an implied license, by virtue of legal estoppel, to later-issued patents that are necessary to practice the subject matter of patents to which rights were granted, even if the agreement includes express language that it does not convey rights to other patents.
In 2000, TransCore, a manufacturer of automated toll collection systems, sued Mark IV Industries, a competitor, for patent infringement. The parties resolved the action by a settlement agreement pursuant to which Mark IV agreed to pay TransCore $4.5 million, TransCore released all existing claims against Mark IV and TransCore agreed to an unconditional covenant not to sue Mark IV for infringement of certain patents owned by TransCore.
Subsequent to entering into the settlement agreement with TransCore, Mark IV sold toll collection systems to the Illinois State Highway Authority (“Highway Authority”), which engaged Electronic Transaction Consultants (“ETC”) to install and test the systems. Based on this work for the Highway Authority, TransCore sued ETC for infringement of (i) the patents that were the subject of the settlement agreement with Mark IV and (ii) one additional patent.
In May 2008, the District Court for the Northern District of Texas granted summary judgment in favor of ETC based on ETC’s claims that its actions were authorized by the settlement agreement pursuant to patent exhaustion, implied license and legal estoppel. TransCore appealed to the Federal Circuit.
When considering TransCore’s appeal, the Federal Circuit referred to the U.S. Supreme Court’s decision in the recent Quanta case to reiterate the longstanding patent exhaustion doctrine, which states that the first authorized sale of a patented product terminates all patent rights to that product. Quanta Computer, Inc. v. LG Electronics, Inc., 128 S. Ct. 2109 (2008).
The Federal Circuit then looked to the TransCore-Mark IV settlement agreement, specifically at the unrestricted covenant not to sue, to determine whether Mark IV’s sale of the toll collection systems was authorized by TransCore. In determining whether that covenant not to sue authorized Mark IV to sell items that infringe TransCore’s patents, the court relied on precedent which holds that covenants not to sue and nonexclusive licenses have identical effects. Applying this concept to the TransCore-Mark IV settlement agreement, the court found that TransCore’s unambiguous and unrestricted covenant not to sue did indeed authorize Mark IV’s sale of the products that infringe the TransCore patents.
Because the sale of infringing items by Mark IV to the Highway Authority was authorized by TransCore, TransCore’s patent rights in such items were exhausted by that sale. Therefore, ETC did not infringe TransCore’s patent rights.
Next, the Federal Circuit found in favor of ETC with respect to legal estoppel, finding that ETC had an implied license to a patent that was not explicitly subject to the TransCore-Mark IV settlement agreement. In doing so, the court expanded earlier legal estoppel law, which had stated that a patent licensor is estopped from asserting a previously issued patent to detract from a patent license that had been granted. The Federal Circuit expressed its belief that the legal estoppel doctrine should not be limited to previously issued patents only, and held that it should apply to later-issued patents that are necessary to practice expressly licensed patents. The court came to this conclusion even in the face of express language in the TransCore-Mark IV settlement agreement that stated that the covenant not to sue did not apply to any other patents issued in the future, stating that the language did not permit TransCore to detract from the rights it had expressly granted.
So what does this decision mean for parties contracting with respect to patent rights? First, an unrestricted covenant not to sue results in exhaustion in the same manner as an unrestricted nonexclusive license. Parties should be sure to consider and include any restrictions on a covenant not to sue with the same precision and care that are typically brought to bear when drafting a license agreement. Second, a patent owner should not rely on a generic reservation of rights clause in the hopes of preserving rights to a to-be-issued patent that is arguably necessary to practice expressly licensed patent rights. To do so may result in the granting of a royalty-free implied license. Instead, the patent owner should expressly address the license rights and royalty obligations with respect to those patents.