High Court of Australia allows sale of modified cartridges, adopts exhaustion doctrine over implied licence

Nik Ramchand, Suzy Roessel and Lachlan Sadler

The High Court has delivered its eagerly anticipated judgment in Calidad Pty Ltd v Seiko Epson Corporation [2020] HCA 41 and overturned the decision of the Full Federal Court by a narrow 4-3 majority. The majority held that Calidad’s ‘modified’ printer cartridges do not infringe Seiko’s patents, and further found that patent owners cannot use the patent system to control or limit what may be done with a patented product after it has been sold by (or with the licence of) the patent owner because the patent owner’s rights are “exhausted” upon such sale. This adoption of an “exhaustion doctrine” overturns a century of jurisprudence.

The two competing doctrines – ‘implied licence’ and ‘exhaustion’

The key question brought before the High Court in this case was whether patent owners can use the patent system to control or limit what may be done with a patented product after it has been sold by (or with the licence of) the patent owner (patentee).

This question required the High Court to consider which of two competing doctrines should apply in Australia: the ‘implied licence’ doctrine, or the ‘exhaustion’ doctrine. Both doctrines limit the extent to which a patentee can enforce its rights against purchasers of its patented goods. The implied licence doctrine was applied by the Federal Court and Full Federal Court earlier in this dispute, on the basis that it was the prevailing law in Australia. However Calidad reserved its right to argue before the High Court that the exhaustion doctrine should be adopted in Australia, and apply in this case.

According to the implied licence doctrine, the sale of a patented product by or with the consent of the patentee includes an implied licence that the purchaser may use the product as they see fit without infringing the rights of the patentee. The patentee may attach conditions to the sale to control how the product may be used. However, a subsequent purchaser will only be bound by these conditions if they knew about them when they purchased the product.

The doctrine of exhaustion, on the other hand, holds that the rights of a patentee come to an end (are exhausted) when the patented product is first sold by, or with the authorisation of, the patentee. The patentee may enter into a contract with a purchaser to limit how the purchaser may use the patented product. However, in the event that the purchaser breaches these conditions, the patentee will have a cause of action for breach of contract, not patent infringement.

While the differences between the two doctrines may be semantic in some cases, there are significant practical consequences of adopting one doctrine over the other with respect to the remedies available to the patent owner. Because under the exhaustion doctrine a patentee’s rights against a purchaser who does not abide by the patentee’s conditions are limited to breach of contract, the adoption of this doctrine means that the patentee is not entitled to seek an injunction under the Patents Act in the event that a purchaser breaches its obligations. In addition, under the exhaustion doctrine, subsequent purchasers can do what they like with the product (including parallel importation), even if they know about the conditions the patentee put on the first sale of the product.

Calidad’s sale of modified and re-filled single-use Seiko printer cartridges

As set out in our previous article on the original single-judge decision, Seiko Epson Corporation (Seiko) sold Epson printer cartridges (Epson Cartridges) which could only be used in Epson printers, and which ceased working once they ran out of ink. Seiko is the registered owner of various patents relating to these single-use cartridges, including the two patents it asserted against Calidad (the Patents).

The Patents do not concern the technology used to render the cartridges unusable after one use, but rather were primarily directed to the layout of the electrical terminals in the cartridges which was designed to prevent a short circuit if spilt ink joined the terminals.

Ninestar (a Malaysian company) acquired large volumes of used Epson Cartridges from outside Australia, and then refurbished, reprogrammed, rebranded, and refilled these cartridges so that they became Calidad printer cartridges (Calidad Cartridges) which were compatible with the Epson printers for which they were originally designed (and in some cases, due to the modifications, were compatible with a broader range of Epson printers than those for which they were originally designed). The Calidad Cartridges were then imported by the Calidad group of companies (Calidad) and sold in Australia.

It was common ground that the Calidad Cartridges embodied the inventions claimed in the Patents. The relevant question was whether Calidad was protected from Seiko’s patent infringement claim because the Calidad Cartridges were simply modifications of Epson Cartridges originally sold by Seiko.

The Federal Court proceedings

Justice Burley at first instance found that some cartridges infringed while others did not. His Honour’s findings are set out in full in our previous article.

Justice Burley applied the ‘implied licence’ doctrine, which would protect Calidad from infringement because when it bought the Calidad Cartridges from Ninestar, it was not aware of Seiko placing any restrictions on the use, modification or subsequent re-sale of the Epson Cartridges. However, this protection does not extend to the sale of cartridges which have been materially altered to such an extent that the implied licence had been ‘extinguished’. Justice Burley found that only some of the cartridges were sufficiently altered to extinguish the implied licence, but that dealings with other, less modified cartridges were protected by the implied licence.

On appeal, the Full Court unanimously found that all the Calidad Cartridges infringed the Patents. The Full Court held that the modifications performed on the Epson Cartridges by Ninestar were properly considered as ‘remaking’ the cartridges. In these circumstances, the Calidad Cartridges were not simply modified Epson Cartridges, but essentially new cartridges made from the parts of Epson Cartridges, and, as such, were not covered by the implied licence. A crucial factor in this finding was that the Epson Cartridges were designed to cease functioning after they ran out of ink. By altering the cartridges to circumvent this limitation, Ninestar was changing the purpose and design of the products in a significant way, making new products.

Regardless of the doctrine, the High Court found that Calidad did not infringe the Patents

Chief Justice Kiefel and Justices Bell and Keane delivered the leading High Court judgment, with which Justice Gageler agreed. The majority held that, regardless of which doctrine was preferred, the Full Court had erred in finding that the Calidad Cartridges had infringed the Patents.

According to the majority, the Full Court had erroneously focused on the fact that the cartridges were designed for a single use (making reference to Seiko’s intentions). The High Court majority held that these intentions were not relevant to the question of infringement, as the Patents are not directed to the single-use aspect of the cartridges.

The relevant question was whether the activities of Ninestar involved impermissibly ‘remaking’ the claimed cartridges, or instead involved merely repairing the cartridges (a permissible activity). According to the reasoning of the majority, if Ninestar’s activities had not involved the replication of the combination of patent claim integers that describe the cartridge, then it had not relevantly ‘made’ the cartridge.

The majority considered that Ninestar had not remade the cartridges, as the particular layout of the electrical terminals on the Epson Cartridges (which was the invention claimed in the Patents) was not altered by Ninestar’s modifications, even where Ninestar had made a hole in the cartridges to refill them with ink or reprogrammed the memory chip. The making of the holes did not cause the cartridge to “cease to exist”, nor was it “made anew” when the holes were sealed (as the Full Court had found). Likewise, the majority found that the product did not “cease to exist” when the memory chip was substituted, making reference to the US decision of Wilson v Simpson, in which the Court refused to accept that a machine ceased to exist because an inoperative part was repaired or replaced.

As Ninestar’s modifications did not involve the “replication of parts and features of the invention claimed”, they did not constitute ‘making’ the invention and therefore did not infringe the Patents.

This reasoning indicates that the High Court has adopted a narrower interpretation of what amounts to “making” than that adopted by the Full Federal Court, and interpreted the modifications as consistent with “the rights of an owner to alter an article to improve its usefulness and enable its re-use”. This confirms that a ‘right to repair’ exists in Australian patent law (regardless of which doctrine is preferred), which enables a purchaser, absent restrictions imposed by the seller, to modify a product so as to extend its useful life.

The High Court adopted the doctrine of exhaustion

While this was sufficient to resolve the appeal, the majority nevertheless held that the doctrine of exhaustion should be adopted in Australia for the reasons listed below.

  1. The doctrine of exhaustion is logical and simple, whereas the implied licence doctrine may give rise to difficult questions concerning whether restrictions were imposed on a purchaser and whether subsequent purchasers knew about these restrictions when they purchased the product.
  2. The doctrine of exhaustion is coherent with a fundamental tenant of the common law that respects the right of owners of chattels to use those chattels.
  3. The implied licence is a legal fiction. It arises without any explicit agreement and also cannot be implied into the sale of goods by traditional means.
  4. The implied licence doctrine is not consistent with the certainty demanded by trade and commerce, which requires that the owner of a chattel should have full rights to use and dispose of that chattel. The implied licence cuts across this by treating a restriction on the use or sale of the product as running with it, binding all subsequent owners with notice of the restriction.
  5. The doctrine of exhaustion has been adopted in other jurisdictions, including the United States and the Court of Justice of the European Union.
  6. The doctrine of exhaustion is not inconsistent with the rights conferred on a patentee by the Patents Act, which are negative in nature. The definition of “exploit” in the Patents Act, which defines the monopoly of a patentee, does not suggest that the sale of a patented product should be understood any differently to an ordinary sale which carries with it the unrestricted right to use the purchased product.
  7. The doctrine of exhaustion is consistent with the purposes of the Patents Act, which include ensuring the efficiency of the market economy and encouraging innovation. These objectives are achieved by ensuring that a patentee is rewarded for their efforts through the sale of a product embodying their invention. There is nothing to suggest that a patentee should be rewarded more than once.
  8. The extrinsic materials to the Patents Act and its predecessors do not suggest that the Patents Act was premised on either doctrine, which leaves the adoption of either doctrine open to the courts.
  9. The implied licence doctrine has only been applied in a handful of decisions and, as such, no great inconvenience would be caused by abandoning it.
  10. Justice Gageler also considered that amendments to the Competition and Consumer Act 2010 (Cth) last year already limited the extent to which patentees are entitled to apply restrictions on the use or resale of patented goods by purchasers.

The minority held that the implied licence doctrine should be followed

Justices Nettle, Gordon, and Edelman held that the implied licence doctrine should continue to apply in Australia and that the doctrine of exhaustion should not be adopted, for the reasons listed below.

  1. The implied licence theory is longstanding in Australian and UK law and has been repeatedly relied upon for over a century.
  2. Adopting the doctrine of exhaustion would diminish the rights granted to patentees under the Patents Act, which should not occur unless there is a “principled reason” for such a change.
  3. A change of this nature is a question for the legislature, not the courts.
  4. Considering whether the doctrine of exhaustion should be applied is unnecessary in order to resolve the appeal in question and, as such, this case is not a suitable vehicle for the resolution this issue.
  5. The rights of a patentee are not merely negative rights, but also include a positive right to vend (sell) the invention. As such, the implied licence doctrine is consistent with the rights of a patentee under the Patents Act, which include an implicit freedom for patentees to grant rights to deal with patented products conditionally as they see fit. This positive right would be limited by adopting the doctrine of exhaustion.
  6. The implied licence doctrine is consistent with equitable principles that bona fide purchasers for value without notice take their rights free from prior interests, whereas purchasers with notice of restrictions may take their rights subject to these restrictions.
  7. The doctrine of exhaustion has been developed and applied overseas, in different legal contexts to Australia.
  8. At the time the Patents Act was enacted, it was settled law that the implied licence doctrine applied in Australia. If lawmakers intended to reverse this settled understanding, it would have been explicit in the statute.

The minority held that some cartridges but not others had infringed the Patents

The dissenting judgment then considered whether Calidad had infringed the Patents.

The minority agreed with the majority that it was irrelevant whether the doctrine of exhaustion or the implied licence doctrine was applied in this case, and also that the nature of the Epson Cartridges as single use goods was “largely irrelevant” to this question.

The minority therefore held that most of the Calidad Cartridges were protected by the implied licence, for reasons similar to that of the majority.

In the case of some cartridges, Ninestar had cut off the interface pattern (a series of protruding “ribs” on the exterior surface of the cartridge which made the cartridge compatible with certain printers) to make the cartridges fit a different printer. The minority held that the cartridges that were so modified were not protected by the implied licence. These modifications were so significant so as to change the form and function of the cartridges and therefore amounted to ‘making’ the patented product, which was not protected by the implied licence.

Take home points for practitioners, patentees, and purchasers of patented products

While the High Court’s finding that Calidad has not infringed Seiko’s patents will no doubt be the primary concern for the parties, it is the adoption of the doctrine of exhaustion in Australian patent law which will have a lasting impact for practitioners, patentees, and purchasers of patented goods.

Companies which run similar businesses for repairing, modifying or refurbishing goods will be reassured by the outcome, as will companies which conduct third party repairs on patented goods such as smartphones. The judgment also confirms the rights of individuals who purchase products, which include the right to re-sell, repair, or modify these goods.

Notwithstanding this, the High Court majority emphasised that a patentee is not prevented from imposing restrictions and conditions on the use of a patented product after its sale by negotiation, which can be enforced by the law of contract or in equity. For example, the patentee may impose a restriction that the purchaser cannot resell or modify the purchased product. However, in the event that these obligations are breached, any remedy will now be for breach of contract and not for patent infringement, unless it can be shown that the actions of the purchaser amounted to ‘re-making’ the patented product within the narrow interpretation applied by the High Court in this case.

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