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Patent Exhaustion Is a Defense to Patent Infringement, Not a Cause of Action

September 16, 2008

Decision icon Decision

Last Month at the Federal Circuit - October 2008

Judges: Mayer, Lourie (author), Schall

[Appealed from: N.D. Ill., Judge Der-Yeghiayan]

In ExcelStor Technology, Inc. v. Papst Licensing GMBH & Co. KG, No. 08-1140 (Fed. Cir. Sept. 16, 2008), the Federal Circuit affirmed the district court’s dismissal of ExcelStor Technology, Inc., ExcelStor Technology, Ltd., ExcelStor Group Ltd., ExcelStor Great Wall Technology Ltd., and Shenzhen ExcelStor Technology Ltd.’s (collectively “ExcelStor”) complaint for lack of subject matter jurisdiction.

In January 2004, ExcelStor entered into a licensing agreement with Papst Licensing GMBH & Co. KG (“Papst”) under which Papst permitted ExcelStor to manufacture patented hard disk drives in exchange for royalty payments. The agreement also required Papst to notify ExcelStor of the existence of any other royalty-bearing licenses for the drives. Papst sent notices to ExcelStor reporting that it was not receiving any royalty payments from third parties on the drives. At some point, ExcelStor became aware of a license agreement between Papst and Hitachi Corporation (“Hitachi”) and was concerned that the Hitachi agreement involved royalty payments for the drives that ExcelStor was manufacturing. Papst assured ExcelStor that Hitachi was not paying royalties, but ExcelStor sued Papst, claiming fraud and breach of contract.

Papst filed a motion to dismiss for lack of subject matter jurisdiction. In response, ExcelStor filed an amended complaint that included numerous references and citations to federal patent law. The amended complaint included four claims for relief, three of which (Counts I, III, and IV) are at issue here. Count I requested a DJ that Papst had violated the “Patent Exhaustion/First Sale doctrine” by collecting two royalties from the sale of the same patented hard disk drives. Count III was a fraud claim arising from Papst’s alleged failure to disclose its violation of the patent exhaustion/first sale doctrine. Count IV was a breach of contract claim regarding Papst’s alleged failure to notify ExcelStor of its violation of the patent exhaustion/first sale doctrine. The district court dismissed ExcelStor’s complaint for lack of subject matter jurisdiction, finding that none of its claims was based on federal patent law and that ExcelStor was thus not entitled to proceed in federal court. ExcelStor appealed.

On appeal, the Federal Circuit noted that where, as here, ExcelStor did not claim diversity of citizenship, there must be federal question jurisdiction. ExcelStor claimed that jurisdiction was proper under 28 U.S.C. § 1338, which provides district courts with exclusive federal jurisdiction over “any civil action arising under any Act of Congress relating to patents.” Slip op. at 4. ExcelStor argued that Counts I, III, and IV of its amended complaint arose under the patent exhaustion doctrine of patent law, and were therefore within the jurisdiction of the federal courts. The Federal Circuit disagreed, concluding that ExcelStor’s claims failed to establish “either that federal patent law create[d] the cause of action or that the plaintiff’s right to relief necessarily depend[ed] on resolution of a substantial question of federal patent law, in that patent law [was] a necessary element of one of the well-pleaded claims.” Id. (citing Christianson v. Colt Indus. Operating Corp., 486 U.S. 800, 809 (2005)).

The Federal Circuit determined that patent law did not create the cause of action in this case because patent exhaustion is a defense to patent infringement, not a cause of action. The Court also found that ExcelStor’s claims did not establish federal subject matter jurisdiction because they did not require resolution of a substantial question of federal patent law. It explained that the exhaustion doctrine prohibits patent holders from selling a patented article and then invoking patent law to control postsale use of the article. The Court noted that ExcelStor’s amended complaint included no such allegation and that it instead alleged that Papst violated the patent exhaustion doctrine by collecting two different royalties from the same patented product.

The Court reasoned that there was no federal cause of action for collecting royalties twice on the same goods. Although patent exhaustion prohibits patentees from enforcing patent rights in certain circumstances, it does not forbid multiple licenses on a single product or even multiple royalties. The Court added that Papst’s alleged collection of two sets of royalties in this case may eventually prove to have been prohibited by the terms of the individual license agreements, or such a collection scheme may prove to have been fraudulent, but patent law was not a necessary element of such determinations. The Court noted that such allegations are properly made in this case in state, not federal, courts, under state law of contract and fraud. Accordingly, the Court affirmed the district court’s dismissal of ExcelStor’s complaint for lack of subject matter jurisdiction.