Federal Circuit Sides with Papst in ExcelStor's Hard Drive Patent Action

Holding:

The U.S. Court of Appeals for the Federal Circuit held that plaintiffs in this breach of contract suit can not invoke the patent exhaustion doctrine as a separate cause of action, since such doctrine is a defense to a patent infringement suit. Plaintiffs ExcelStor, et al. licensed their patents for hard drive disks to Papst Licensing GMBH & Co. KG ("Papst"), but later sued Papst for patent exhaustion after Papst entered into another license agreement with Hitachi Corporation. The district court dismissed ExcelStor’s complaint for lack of subject matter jurisdiction. On appeal, the Federal Circuit affirmed the dismissal, stating that ExcelStor’s amended complaint did not allege that Papst invoked patent laws to control the post-sale use of the hard disk drives. Instead, ExcelStor’s amended complaint alleged that Papst violated the patent exhaustion doctrine by “collecting two different royalties from the same patented product.” But the Federal Circuit held there is no federal cause of action for collecting royalties twice on the same goods. Patent exhaustion prohibits patentees from enforcing patent rights in certain circumstances, but it does not forbid multiple licenses on a single product or even multiple royalties. Because patent law did not create the cause of action in this case, the dismissal for lack of subject matter jurisdiction was warranted.

Detailed Summary:

Plaintiffs-appellants ExcelStor Technology, Inc., ExcelStor Technology, Ltd., ExcelStor Group Ltd., ExcelStor Great Wall Technology Ltd., and Shenzhen ExcelStor Technology Ltd. (collectively “ExcelStor” or “appellants”) appealed from the decision of the U.S. District Court for the Northern District of Illinois granting Papst’s motion to dismiss. Opinion, p. 1, citing ExcelStor Tech., Inc. v. Papst Licensing GMBH & Co. KG, No. 07-C2467, 2007 U.S. Dist. LEXIS 79305 (N.D. Ill. Oct. 24, 2007.

By way of background, in January 2004, ExcelStor, a manufacturer of computer products, entered into a licensing agreement with Papst. Id., p. 2.  In that agreement, Papst permitted ExcelStor to manufacture patented hard disk drives in exchange for royalty payments. The agreement also required Papst, on a quarterly basis, to notify ExcelStor of the existence of any other royalty-bearing licenses for the patented hard disk drives. ExcelStor alleged that Papst sent numerous notice letters over a period of nearly three years indicating that no royalties were being paid, other than those paid by ExcelStor. Id.

At some point in 2006 or 2007, ExcelStor became aware of a license agreement between Papst and Hitachi Corporation (the “Hitachi agreement”). Papst allegedly assured ExcelStor that Hitachi was not paying royalties, and that the Hitachi agreement had been entered into after the formation of the ExcelStor agreement. Id. Papst also continued to send notice letters to ExcelStor reporting no royalty payments from third parties on the hard disk drives.

According to ExcelStor, Papst’s representations and the notice letters were fraudulent. Id. It further alleged that the Hitachi agreement involved royalty payments for the hard disk drives that ExcelStor was manufacturing. Id.

Accordingly, ExcelStor brought an action, claiming fraud and breach of contract, in the U.S. District Court for the Northern District of Illinois. In response, Papst filed a motion to dismiss for lack of subject matter jurisdiction. ExcelStor responded by filing an amended complaint that included numerous references and citations to federal patent law.

The district court dismissed ExcelStor’s complaint for lack of subject matter jurisdiction. As to Count I (“Patent Exhaustion/First Sale doctrine”) of the complaint, the district court held that since patent exhaustion was a defense to patent infringement and not, as ExcelStor believed, a cause of action sufficient to grant the relief sough, the mere citation of federal patent law was insufficient to confer federal jurisdiction over the case.  Id., p.3. The district court then found that Count III (fraud claim arising from Papst’s alleged failure to disclose its violation of the Patent Exhaustion/First Sale Doctrine) and Count IV (breach of contract claim)  were not based on federal patent law, and that ExcelStor was not entitled to proceed in federal court. Id.

In this appeal, ExcelStor argued that the three causes of action at issue arose under federal patent law. Id., p. 5. ExcelStor also claimed that Counts I, III, and IV arise under the patent exhaustion doctrine of patent law, and are therefore within the jurisdiction of the federal courts. Id.

The Federal Circuit however rejected such arguments, stating that patent law did not create the cause of action in this case. In so saying, it affirmed the district court’s holding that patent exhaustion is a defense to patent infringement, not a cause of action.  Id, referring to Monsanto Co. v. Scruggs, 459 F.3d 1328, 1332-36 (Fed. Cir. 2006). Thus, ExcelStor’s claims, which merely invoked defenses to hypothetical claims of patent infringement, did not “arise under” the patent laws. Id., citing Christianson v. Colt Industries Operating Corp., 486 U.S. 800, 809 (2005).

The Federal Circuit added 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. Id.  The exhaustion doctrine prohibits patent holders from selling a patented article and then “invoking patent law to control postsale use of the article.” Id., citing Quanta Computer, Inc. v. LG Elecs., Inc., 553 U.S. ___, 128 S. Ct. 2109, 2122 (2008).

Here, ExcelStor’s amended complaint did not allege that Papst invoked the patent laws to control the post-sale use of the hard disk drives. Instead, ExcelStor’s amended complaint alleged that Papst violated the patent exhaustion doctrine by “collecting two different royalties from the same patented product.” Id., p. 6, citing Appellants’ Am. Compl. at 3. But there is no federal cause of action for collecting royalties twice on the same goods. Patent exhaustion prohibits patentees from enforcing patent rights in certain circumstances, but it does not forbid multiple licenses on a single product or even multiple royalties. Id.

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 is not a necessary element of such determinations. They are properly made in this case by state, not federal, courts, under state law of contract and fraud. Id.

On the basis of the foregoing, the Federal Circuit affirmed the district court’s dismissal of ExcelStor’s action for lack of subject matter jurisdiction.

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