Last May, the U.S. Supreme Court issued a highly-anticipated decision in Impression Products, Inc. v. Lexmark Int’l, Inc., reversing the Federal Circuit and holding that, when a patent holder sells a product, it exhausts all of its patent rights in the product, regardless of certain restrictions that the patent holder sought to impose on further resale. The Court held that exhaustion applies whether the product was sold internationally or within the United States, such that the patent holder may not bring an infringement claim for otherwise-infringing activities once the product has already been sold by the patent holder or its licensee authorized to do so.
On its face, the decision presents a number of challenges for drug companies, who, on the one hand, frequently commercialize their products through complex networks with multiple tiers of licensees and distributors, and on the other hand, seek to impose limitations on the jurisdictions and fields in which their licensees and distributors may sell their products. Here are five takeaways for drug companies in light of the Lexmark decision:
Your patents don’t provide quite the protection they used to. The Supreme Court’s decision takes from patent holders a right that they enjoyed under the Federal Circuit’s original holding, namely, the right to bring certain patent infringement lawsuits against a purchaser outside the U.S. that carries out post-sale infringing activities inside the U.S.. In light of the Lexmark decision, the patent holder might have a breach of contract claim against certain purchasers, but not an infringement claim.
You can still enforce your patent against your licensee. The Lexmark decision goes to some lengths to clarify that a licensee (who is not itself a purchaser) may still be subject to restrictions such as a specific territory or a particular field, and that only an authorized sale by the licensee (or patent holder) exhausts the patent holder’s IP rights. The patent holder can still assert infringement against a licensee who engages in activities outside the scope of its license, and can still enforce its patent against persons buying through the licensee where the patent holder has not given authority to the licensee to make the sale. The latter point raises the question of what constitutes an authorized sale. For example, what if the downstream customer believed in good faith that the sale was authorized? And can a subsidiary selling under a foreign patent extinguish domestic patent rights by authorizing a foreign sale? The Court did not explore these questions, aside from reaffirming that a sale by a licensee in accordance with the terms of a license is effectively authorized by the patent holder.
But remember that a distribution agreement is different from a pure license. In the case of a distribution arrangement, where the patent holder sells product to a distributor who sells to customers, the patent holder is viewed as fully compensated under the first sale, such that certain further restrictions may be imposed through contract, but not under patent. The key implication is that, in contrast to a pure license, where all activities covered by the patent but not included in the license may be prohibited by both the patent and the contract, under a typical distribution agreement, any activities that the patent holder wants to prohibit must be expressly prohibited in the contract. Any remedies that the patent holder wants to attach to those prohibitions must be spelled out as well. A good example is the case of parallel imports. Before Lexmark, a patent holder might be able to bring an infringement lawsuit against a downstream customer that sells goods into the U.S. without the patent holder’s authorization. After Lexmark, no infringement suit would be possible if there was an authorized sale. Therefore, in order to have any remedy in the event of such activity, it is crucial for the patent holder to include clear and enforceable covenants by the distributor that it will not resell the products into the U.S., to require the distributor to pass such restrictions though to all downstream customers, and to make the patent holder a third-party beneficiary with the right to enforce those restrictions directly against the downstream customers. Some commentators have speculated that, to keep the infringement claim as an available recourse, clever licensors might avoid the “first sale” altogether by structuring would-be sales as licenses, and by requiring distributors to “license” products to wholesalers and customers rather than selling them. While a license approach might be worth exploring higher up in the distribution network (e.g., to wholesalers), it is very difficult to envision a day when individuals would not purchase drugs, but rather receive a license to “use” a drug by ingesting it.
You should employ practical measures to restrict use. Because geographic and field-related prohibitions may be more difficult to enforce in light of the Lexmark decision, and because it is generally advisable for a company to avoid suing its customers, the best course of action is to take practical measures to limit the downstream customers’ ability to engage in undesirable behavior. For a drug company, those measures could include distributing through subsidiaries in foreign markets, eliminating extra “middlemen” in the distribution chain, drop-shipping products to customers, distributing finished drug products rather than API where possible, packaging products in a manner that deters unauthorized use (e.g., with more substantial packaging, in the language of the relevant jurisdiction, and with more prominent language regarding intended use), and limiting the amount of documentation and technology transferred to customers.
The regulatory regime can be your friend. Of course, drug companies are not fully exposed to misuse and re-importation of their products, as most regulatory agencies worldwide (and the U.S. FDA in particular) prohibit off-label use of drugs, as well as the importation of drugs intended for sale in a different jurisdiction. Nonetheless, at the margins, field and territorial restrictions may be more difficult to enforce in light of the Lexmark decision.
In view of the sweeping change imposed by Lexmark, patent holders should ensure that their license agreements are carefully drafted in view of the new law, and that their approach to the distribution and sale of products is well thought out to minimize the risk of undesired activities by downstream customers.