Exhaustion Finally Exhausted: International Exhaustion Now Applies to Copyrighted Works

On March 19, 2013 in the case of Kirtsaeng v. John Wiley, the United States Supreme Court decided a case issued a decision that could significantly drastically change international markets in products that are subject to copyright law. The Court interpreted the 1976 Copyright Act’s language regarding the “first sale” doctrine (or “exhaustion”) to allow unauthorized importation into the United States of products embodying copyrighted works if the copyright owner authorized the original sale overseas, irrespective of where those products were manufactured. . In other words, once a good is sold through normal channels in another country (for instance, Thailand), there is nothing the copyright holder can do under U.S. copyright law to stop its importation into the United States.

The issue of United States law on international exhaustion of IP rights has hit the headlines as a result of the United States Supreme Court’s decision in Kirtsaeng v. John Wiley & Sons Inc., 568 U.S. ____ (2013). John Wiley publishes textbooks, some of which are printed in the United States. Other textbooks having the same content are printed in Asia by a wholly owned subsidiary. Those printed in Asia contain the following statement:

This book is authorized for sale in Europe, Asia, Africa and the Middle East only and may not be exported out of these territories. Exportation from or importation of this book to another region without the Publisher’s authorization is illegal and is a violation of the Publisher’s rights.

While a student in the United States, Mr. Kirtsaeng imported textbooks printed by Wiley in Asia and sold them to his fellow students in the United States. Because the price charged in Asia for the books printed there was significantly lower than the price charged in the United States for books printed in the United States, Mr. Kirtsaeng made a profit.

In an earlier case Omega S.A. v. Costco Wholesale Corp., (2008), the Ninth Circuit had held that there was no international exhaustion of rights in copyright when product was sold abroad by or with the consent of the U.S. copyright holder and subsequently imported into the United States. The Supreme Court granted certiorari on that case, but was split 4-4 on the decision, so that the Ninth Circuit’s decision stood. The Kirstaeng case gave the Supreme Court the opportunity for another look at the issue.

The Copyright Case

Wiley sued Mr. Kirtsaeng for copyright infringement, alleging that the importation of the books was a violation of 17 U.S.C. § 602(a)(1), which provides that

[i]mportation into the United States, without the authority of the owner of copyright under this title, of copies … of a work that have been acquired outside the United States is an infringement of the exclusive right to distribute copies … under section 106 … (Emphasis added)

The Majority Opinion

For Justice Breyer, and five other justices who joined him in holding Mr. Kirtsaeng’s activities did not constitute infringement, the case turned on the meaning of words italicized above. Section 106 of the 1976 Copyright Act provides that the exclusive distribution right given by that statute is subject, inter alia, to 17 U.S.C. § 109(a), which states the following:

Notwithstanding the provisions of section 106(3), the owner of a particular copy or phonorecord lawfully made under this title, or any person authorized by such owner, is entitled, without the authority of the copyright owner, to sell or otherwise dispose of the possession of that copy or phonorecord.

Wiley argued that the words “lawfully made under this title” mean that the provisions of 17 U.S.C. § 109(a) (the “first sale doctrine”) only apply to copyright works that are manufactured in the United States. The Second Circuit Court of Appeals upheld that interpretation. The Supreme Court did not. Justice Breyer parsed the phrase “lawfully made under this title” as follows:

The first two words of the phrase, “lawfully made,” suggest an effort to distinguish those copies that were made lawfully from those that were not, and the last three words, “under this title,” set forth the standard of “lawful[ness].”

Consequently, it was wrong to read a geographical limitation into the phrase as to the location of the manufacture of the books. Reading a geographical limitation into the location for the first sale of the books was, in the view of the Supreme Court, precluded by the Court’s earlier decision in Quality King Distributors v L’anza Research International Inc., 523 U.S. 135 (1998). In that case, the Court held that the importation into the United States of products first sold abroad, but manufactured in the United States, was not a copyright infringement because of the first sale doctrine. (Justices Kagan and Alito commented that if Congress felt it necessary to reconsider the application of the first sale doctrine to questions of importation, the real culprit was the Quality King decision.)

The Court went on to note that the first sale doctrine had its origin in common law, having been first codified in 1909, and that no case law had imposed any geographical limitation. After quoting a passage in Coke on Littleton from the early seventeenth century (before the first copyright statute) about the lack of rights of a horse seller to control any subsequent alienation of the horse because this would be “against Trade and Traffi[c]” (that is in restraint of trade), Justice Breyer moved swiftly to the conclusion that “American law too has generally thought that competition, including freedom to resell, can work to the advantage of the consumer.” Furthermore, a number of practical problems would arise if the first sale doctrine were limited to works printed in the United States. The Court noted that “libraries, used-book dealers, technology companies, consumer-goods retailers, and museums point to various ways in which a geographical interpretation would fail to further basic constitutional copyright objectives, in particular ‘promot[ing] the Progress of Science and useful Arts.’” The primary objective was to prevent piracy and this does not require limitation of the first sale doctrine to books manufactured in the United States.

The Court noted the following:

Wiley and the dissent claim that a non-geographical interpretation will make it difficult, perhaps impossible, for publishers (and other copyright holders) to divide foreign and domestic markets. We concede that is so. A publisher may find it more difficult to charge different prices for the same book in different geographic markets. But we do not see how these facts help Wiley, for we can find no basic principle of copyright law that suggests that publishers are especially entitled to such rights.

The Constitution describes the nature of American copyright law by providing Congress with the power to “secur[e]” to “[a]uthors” “for limited [t]imes” the “exclusive [r]ight to their … [w]ritings.” … But the Constitution’s language nowhere suggests that its limited exclusive right should include a right to divide markets or a concomitant right to charge different purchasers different prices for the same book, say to increase or to maximize gain. Neither, to our knowledge, did any Founder make any such suggestion. … To the contrary, Congress enacted a copyright law that (through the “first sale” doctrine) limits copyright holders’ ability to divide domestic markets. And that limitation is consistent with antitrust laws that ordinarily forbid market divisions. … Whether copyright owners should, or should not, have more than ordinary commercial power to divide international markets is a matter for Congress to decide. We do no more here than try to determine what decision Congress has taken.

Finally, the Court rejected the argument that the United States had taken a stand against international exhaustion of IP rights in its dealings with other countries based on a lack of evidence that the United States had in fact taken such a position.

The Dissent

An unusual combination of justices (Ginsburg, Kennedy and Scalia, JJ.) dissented, stating the following:

[T]he Court today adopts an interpretation of the Copyright Act at odds with Congress’ aim to protect copyright owners against the unauthorized importation of low-priced, foreign made copies of their copyrighted works. The Court’s bold departure from Congress’ design is all the more stunning, for it places the United States at the vanguard of the movement for “international exhaustion” of copyrights—a movement the United States has steadfastly resisted on the world stage.

Additionally, the dissent noted that:

[b]ecause economic conditions and demand for particular goods vary across the globe, copyright owners have a financial incentive to charge different prices for copies of their works in different geographic regions. Their ability to engage in such price discrimination, however, is under-mined if arbitrageurs are permitted to import copies from low-price regions and sell them in high-price regions.

After analyzing the Quality King decision and concluding that this did not require the conclusion reached by Justice Breyer and the majority, the dissenters concluded

[t]he far more plausible reading of §§109(a) and 602(a), then, is that Congress intended §109(a) to apply to copies made in the United States, not to copies manufactured and sold abroad.

Comments

So far as copyright law is concerned, the question of international exhaustion is therefore not firmly in Congress’ court. It seems highly likely that legislation will be introduced to over-rule the Kirtsaeng decision. Whether such legislation will pass is more difficult to predict. The competing arguments of whether different economic conditions in different parts of the globe justify price discrimination, or whether United States consumers should be able to obtain copyrighted works that have been produced legitimately at the lowest price world-wide, are clearly set out in the majority and dissenting opinions.

In the meantime, it seems likely that copyright holders will modify their pricing and/or sales policies to reflect the fact that low priced products sold in foreign markets may be able to flow freely into the United States. They may also seek further to take advantages of differences that already exist in markets in different parts of the world to try to reduce cross-border sales and in some cases move to licensing of products incorporating copyright materials to try to mitigate the damage done to them by this decision.

Impact on Other IP Rights

But what of other IP rights? Although based on the language of the Copyright law, the majority points out that this is a codification of common law and so its decision may have implications for other IP rights, in particular patents where a first sale doctrine exists and is rooted in case law.

Patents

At least since the United States Supreme Court’s decision in 1873 in the case of Adams v. Burke, 84 U.S. 453 (1984), it has been thought to be settled law that the first authorized sale of a patented product in the United States exhausts the patent owner’s monopoly in the product sold.

Thus, one who purchases from the patentee has the right to use and resell the patented item. In United States v. Univis Lens Co., 316 U.S. 241 (1942), the Supreme Court noted “the purpose of the patent law was fulfilled with respect to any particular article when the patentee has received his reward for the use of his invention by the sale of the article, and that once that purpose is realized the patent law provides no basis for restricting the use and enjoyment of the thing sold.”

There is no Supreme Court case law directly on point as to whether this doctrine applies if the first sale is outside the United States. In Boesch v. Graff, 133 U.S. 697 (1890), the Supreme Court held that there was no impediment to enforcing a United States patent to prevent importation of a product lawfully sold in Germany as a result of a prior user right. This case is often cited for the proposition that sale outside the United States does not have the effect of exhausting the patent right. However, it seems that this may be over extending the true rationale of the case.

The current position on the first sale right in the domestic context was expressed by the Federal Circuit in Hewlett-Packard Co. v. Repeat-O-Type Stencil Manufacturing Corp. Inc., 123 F.3d 1445 (Fed. Cir. 1997), as follows:

Generally, when a seller sells a product without restriction, it in effect promises the purchaser that in exchange for the price paid, it will not interfere with the purchaser’s full enjoyment of the product purchased. The buyer has an implied license under any patents of the seller that dominate the product or any uses of the product to which the parties might reasonably contemplate the product will be put.

As noted above, in Kirtsaeng, the books were sold with a restriction that they were not to be resold in the United States. If the Federal Circuit’s ruling in Hewlett Packard remains good law, this should enable action against imports at least where a similar restriction was imposed at the point of sale. However, the question of whether exhaustion occurs if the patentee imposed a condition when first selling a patented item, and this condition was subsequently breached, is a hotly debated one. The 1992 decision by the Federal Circuit in the case of Mallinckrodt v. Medipart, 24 U.S.P.Q.2d 1173 (Fed. Cir. 1992), attracted much attention as supposedly overturning a century of case law. Patentee Mallinckrodt sold to various hospitals patented medical devices for the delivery of radioactive or therapeutic material for the diagnosis and treatment of pulmonary disease. The devices included the inscription “single use only.” After using the devices once, the hospitals sent the devices to Medipart for sterilization and reconditioning so that the hospitals could reuse the device. Mallinckrodt sued Medipart, alleging patent infringement and inducement to infringe. The District Court granted Medipart’s motion for summary judgment based on non-infringement concluding “that violation of the ‘single use only’ notice cannot be remedied by suit for patent infringement.” The Court considered that the first sale of the device exhausted the patentee’s rights in the device and that the cleaning of the device was a permissible repair and not an impermissible reconstruction.

In reversing this decision, the Federal Circuit considered that if Mallinckrodt’s restriction was a valid condition of the sale under the general law, it was not excluded from enforcement under the patent law. The court considered that:

Unless the condition violates some other law or policy (in the patent field, notably [patent] misuse or antitrust law) … private parties retain the freedom to contract concerning conditions of sale … The appropriate criterion is whether Mallinckrodt’s restriction is reasonably within the patent grant, or whether the patentee has ventured beyond the patent grant and into behavior having an anticompetitive effect not justifiable under the rule of reason. Should the restriction be found to be reasonably within the patent grant, i.e. that it relates to subject matter within the scope of the patent claims, that ends the inquiry. However, should such inquiry lead to the conclusion that there are anti-competitive effects extending beyond the patentee’s statutory right to exclude, these effects do not automatically impeach the restriction. Anticompetitive effects that are not per se violations of law are reviewed in accordance with the rule of reason.

The court stated that if the sale of the device was validly conditioned under the applicable law, such as the law governing sales and licenses, and if the restriction on reuse was within the scope of the patent grant or otherwise justified, then violation of the restriction may be remedied by action for patent infringement.

Despite expectations that the Supreme Court would address this issue in Quanta Computer v. LG Electronics, 553 U.S. 617 (2008), the Court ducked the question and decided the case on the basis that on a proper construction of the documents pertaining to the sale, it had been unrestricted and so exhaustion applied. This term the Supreme Court has another opportunity to consider the issue in Bowman v. Monsanto where seed sold with an original limitation as to its use was replanted in contravention of that limitation. Again, however, the Court may be able to decide the case before it without needing to decide this particular issue.

On the question of international exhaustion, in Jazz Photo Corp. v. ITC, 264 F.3d 1094 (Fed. Cir. (2001), a case relating to the repair of camera bodies in China, some of the cameras having been sold originally in the United States and some outside of it, the Federal Circuit, apparently sua sponte, held:

Underlying the repair/reconstruction dichotomy is the principle of exhaustion of patent right. The unrestricted sale of a patented article, by or with the authority of the patentee “exhausts” the patentee’s right to control further sale and use of that article by enforcing the patent under which it was first sold. In United States v. Masonite Corp, 316 U.S. 265, 278 (1942), the Court explained that exhaustion of the patent right depends on “whether or not there has been such a disposition of the article that it may fairly be said that the patentee has received his reward for the use of the article” … United States patent rights are not exhausted by products of foreign provenance. To invoke the protection of the first sale doctrine, the authorized first sale must have occurred under the United States patent.

However, in LG Electronics, Inc. v. Hitachi, Ltd., 2009 U.S. Dist. LEXIS 20457 (N.D. Cal. Mar. 13, 2009), the Northern District of California noted that in Quanta v. LG, the Supreme Court had been aware that some of the sales took place outside the United States and had not made any distinction with respect to sales inside and outside the United States and applied to doctrine to sales outside the United States. In Fujifilm Corp. v. Benun, 95 U.S.P.Q.2d 1985 (Fed. Cir. 2010), the Federal Circuit held that, notwithstanding some district court holdings to the contrary, the views expressed in Jazz Photo are still good law following the Supreme Court’s Quanta decision. A similar conclusion (that there was no international exhaustion requirement) was reached in the copyright case Omega S.A. v. Costco Wholesale Corp., 541 F.3d 982 (9th Cir. 2008), aff’d by an equally divided court, 562 U.S. ____ (2010), which was a predecessor to Kirstaeng. That conclusion was largely based on the copyright statute, however.

On March 25, 2013, the Supreme Court denied certiorari in Ninestar Technology Co. v. U.S. International Trade Commission when invited to consider “whether the initial authorized sale outside the United States of a patented item terminates all patent rights to that item.” The Federal Circuit had affirmed without opinion a decision of the International Trade Commission to exclude refurbished toner cartridges that had originally been sold abroad by the owner of the U. S. patent. However, when Ninestar disregarded the exclusion order and sanctions against it were sought, Ninestar had argued that the LG decision noted above had overruled the Federal Circuit’s Jazz Photo decision so it should not be required to obey the exclusion order. The Federal Circuit disagreed and Ninestar had sought that the case gave the Supreme Court review.the ideal opportunity to address the issue.

That the Supreme Court chose not to do so may indicate a reluctance to extend the Kirtsaeng decision into the field of patents. Alternatively, it may decided that in view of Ninestar’s conduct in disobeying an exclusion order, this was not the right case on which to address the issue. Finally the Court may already have decided to deal with the issue in Bowman v. Monsanto. Since a decision on that case must be issued by the end of June, we do not have too long to wait.

There are, however, policy reasons to doubt whether the Supreme Court will apply international exhaustion principles to patents even if it gets the opportunity. Unlike the situation with copyright, patents are clearly territorial in scope and the Supreme Court in cases such as Microsoft v, AT&T has been reluctant to give them extraterritorial effect. Also the scope and value, not to say the cost of obtaining, a patent varies from country to country so that it cannot be said that there is some general standard “under” which a patent is obtained. Furtjermore, even though the statutory provisions applied in Kirtsaeng derive from common law, it was the precise language of the statute that was in the end in issue, not the policy underlying the statute.

Trademarks

In the trademark field, gray market goods are commonly on sale within the United States. There are, however, certain requirements for such sales to be legal. Since these are based on statute, the Kirtsaeng decision is unlikely to have any direct impact.

Section 526 of the Tariff Act on its face bars import in the United States “any merchandise of foreign manufacture if such merchandise, or the label, sign, print, package, wrapper, or receptacle, bears a trade-mark owned by a citizen of, or by a corporation or association created or organized within the United States, and registered in the Patent and Trade-mark Office by a person domiciled in the United States …, unless written consent of the owner of such trade-mark is produced at the time of entry.”

However, in K-mart Corp. v. Cartier, lnc., 486 U.S. 281 (1988), the Supreme Court took the view that this provision did not apply where there was common control between the original seller of the goods abroad and the owner of the United States trademark.

Section 42 of the Lanham Act also provides for the possibility of preventing importation of parallel imports. The application of this provision is, however, subject to the so-called Lever rule which derives from the case of Lever Bros. Co. v. U.S., 981 F.2d 1330 (D.C. Cir. 1993) and is codified in United States Customs and Border Protection (CBP) Regulations at 19 C.F.R. §§ 133.2-133.27. Under this rule, parallel imports are permitted subject to certain provisions. However, if there are physical and material differences between the unauthorized imported goods and the United States goods sold under the same trademark or trade name, the United States trademark owner can request the Customs Service to prevent unauthorized importation. For example, if the unauthorized goods (in this case, food) contain different ingredients than the authorized goods, there is a material alteration and the unauthorized goods can be stopped at the United States border. Societe des Produits Nestle, S.A. v. Casa Helvetica, Inc., 982 F.2d 633, 643 (1st Cir. 1992). If the unauthorized product has a different shape or appearance, that is also a material alteration. Id.

The Customs Service regulations provide that physical and material differences to be taken into account may include, but are not limited to, considerations of the following:

1. The specific composition of both the authorized and gray market product(s) (including chemical composition);
2. Formulation, product construction, structure, or composite product components, of both the authorized and gray market product;
3. Performance and/or operational characteristics of both the authorized and gray market product;
4. Differences resulting from legal or regulatory requirements, certification, etc.;
5. Other distinguishing and explicitly defined factors that would likely result in consumer deception or confusion as proscribed under applicable law.

Furthermore, the regulations provide that even if a physical or material difference exists, imports

shall not be detained … where the merchandise or its packaging bears a conspicuous and legible label designed to remain on the product until the first point of sale to a retail consumer in the United States stating that: This product is not a product authorized by the United States trademark owner for importation and is physically and materially different from the authorized product. The label must be in close proximity to the trademark as it appears in its most prominent location on the article itself or the retail package or container.

It is therefore quite difficult for a United States trademark owner to control the sale of products after the original sale. It is generally true that once a product bearing a United States trademark is sold at any location (with permission from the trademark owner), that owner has no ability to control subsequent resale or importation of those goods.

The corollary of the Lever rule is that identical and genuine goods, or goods that contain nonmaterial alterations, can be freely resold and imported without authorization. Trademark owners will be happy to know that the threshold of materiality can be “quite low,” Nestle, 982 F.2d at 641, but a difference in price alone is unlikely to qualify as a material alteration.