District Court Holds That Alleged Violation of Patent Exhaustion Doctrine Does Not Support Federal Question Jurisdiction

U.S. District Judge Der-Yeghiayan in the Northern District of Illinois dismissed a suit alleging that patentee "violated" patent exhaustion doctrine by collecting royalties from the manufacturer as well as purchaser of patented disk drives. The Court held that the exhaustion doctrine operates as a defense to a claim of infringement, but does not support a claim for declaratory judgment or federal question jurisdiction. ExcelStor Technology, Inc. v. Papst Licensing GMBH & Co. KG, No. 07 C 2467 (N.D.Ill., October 24, 2007)

In January, 2004, ExcelStor Technology entered into a licensing agreement (ExcelStor Agreement) with Papst Licensing GMBH & Co. KG which entitled ExcelStor to make and sell hard disk drives (HDDs) covered by a Papst patent in consideration for the payment of royalties to Papst. When ExcelStor entered into the agreement, it was unaware that Papst had already entered into another licensing agreement with Hitachi (Hitachi Agreement), which required Hitachi to cover the payment of royalties for the manufacture of the same HDDs that were the subject of the ExcelStor Agreement. The Court reported that neither ExcelStor nor Hitachi were allegedly aware of the terms of the other party's agreement, each of which included a confidentiality clause.

The ExcelStor Agreement also allegedly required Papst to notify ExcelStor, on a quarterly basis, whether Papst was receiving royalties from a purchaser of HDDs manufactured by ExcelStor. The complaint alleged that Papst sent ExcelStor a notice on April 2, 2004, which falsely reported that Papst was not receiving royalties for the HDDs manufactured by ExcelStor from any source other than ExcelStor.

When ExcelStor obtained copies of the Hitachi Agreement, which revealed Hitachi's obligation to pay royalties, ExcelStor filed suit for a declaratory judgment that Papst violated the patent exhaustion doctrine: a declaratory judgment that the ExcelStor agreement was unenforceable inasmuch as it violated the patent exhaustion doctrine; as well as claims for fraud and breach of contract.

The case came before the Court on Papst's motion to dismiss for lack of subject matter jurisdiction, i.e., that the complaint did not present a question of federal law as claimed by ExcelStor. ExcelStor argued that its claims were based on federal patent law, and subject to federal jurisdiction pursuant to 28 U.S.C. §1338, which provides that "the district courts shall have original jurisdiction of any civil action arising under any Act of Congress relating to patents." In particular, according to the Court, "ExcelStor argues that its claims in the instant action are dependant on a ruling based on the first sale doctrine otherwise referred to as the patent exhaustion doctrine." According to the Court:

ExcelStor contends that this court has subject matter jurisdiction in this case because ExcelStor is entitled to relief under the patent exhaustion doctrine. Under the patent exhaustion doctrine, "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." Jazz Photo Corp. v. International Trade Com'n, 264 F.3d 1094, 1105 (Fed.Cir.2001); LG Electronics, Inc. v. Bizcom Electronics, Inc., 453 F.3d 1364, 1369-70 (Fed.Cir.2006).

According to the Court, however, "the patent exhaustion doctrine is not a source of relief for ExcelStor."

It is not a cause of action that a party can bring and obtain relief such as the damages sought by ExcelStor in this action. Rather, the patent exhaustion doctrine is a defense for claims such as a patent infringement claim, prohibiting a party from suing for patent infringement to protect its proprietary rights since the party is deemed to have already received full compensation for ownership in such rights…. The patent exhaustion doctrine is a defense to a patent infringement claim, barring a party from pursuing an infringement claim if the party has already sold the patent rights to another party.

Moreover, "ExcelStor lacks any legitimate basis to seek a declaration that Section 4.3 of the ExcelStor Agreement violates the patent exhaustion doctrine," according to the Court.

ExcelStor is not entitled in a vacuum to have this court resolve an issue that does not present a live case or controversy. The references to the patent exhaustion doctrine by ExcelStor do not confer federal subject matter jurisdiction, and, as indicated above, parties cannot confer federal subject matter jurisdiction upon themselves. Also, the mere raising of a patent defense does not confer federal subject matter jurisdiction…. Thus, ExcelStor has not shown that the declaratory judgment claims in Counts I and II are based upon federal patent law.

The Court also rejected ExcelStor's argument that the fraud claim is substantially based on patent law because it turns on "Papst's false representation that it had complied with the Patent Exhaustion/First Sale Doctrine." According to the Court:

The Notice Provision does not make any reference to the patent exhaustion doctrine. Nor does the Notice Provision obligate Papst to state whether it is violating the patent exhaustion doctrine. Whether or not Papst violated the Notice Provision depends on whether Papst accurately identified other customers receiving the royalties, not whether it violated the patent exhaustion doctrine.

The Court found "no indication that Papst specifically stated in the notices that it was not violating the patent exhaustion doctrine." The Court concluded that "the determination of whether Papst made misrepresentations in the notices involves a factual inquiry that does not require a consideration of federal patent law. Therefore, ExcelStor has not shown that the fraud claim (Count III) is based upon federal patent law."

The Court similarly rejected ExcelStor's argument that the breach of contract claim is based upon the patent exhaustion doctrine. Like the fraud claim, the breach of contract claim was grounded in Pabst's failure to report additional royalty sources, as required by the Agreement. According to the Court, "in determining the contractual obligations of the parties to the ExcelStor Agreement, the terms and intent of the parties in the formation of that particular agreement govern the precise obligations of the parties."

ExcelStor has not shown that general principles of federal patent law would govern the contractual relationship in any way. The terms of the ExcelStor Agreement provide the necessary guidance to resolve whether Papst breached the agreement and to determine the appropriate remedy for a breach. There is no need to consult the patent exhaustion doctrine. ExcelStor's insertion of the patent exhaustion doctrine into this case does not confer federal subject matter jurisdiction.

Finally, the Court rejected the argument that the state law issues are preempted by federal patent law.

ExcelStor argues that "the parties' license agreement must be construed (and thus enforced) in such a way so as not to exceed the proper scope of the patent monopoly that Papst is allowed to have under U.S. federal patent law…." ExcelStor contends that the federal interest in such a monopoly overrides any state interest. However, as is explained above, this action is premised upon a breach of the terms of the ExcelStor Agreement and alleged fraud involving the execution of the agreement. ExcelStor does not allege that the Notice Provision is ambiguous and that its scope is unclear. Whether Papst violated the terms of the ExcelStor Agreement involves a straightforward examination of the terms and facts in this case. ExcelStor alleges that pursuant to the Notice Provision Papst was supposed to report certain royalties from other customers. Whether or not Papst accurately provided such notice is a question of fact. ExcelStor has not shown how any interpretations concerning the scope of the ExcelStor Agreement and its relation to Papst's patent monopoly would come into play in such an analysis. Therefore, ExcelStor has not shown that the state law issues in this case would be preempted by federal law. Also, the possibility that ExcelStor might raise federal preemption as a defense in a state action is not itself a basis for federal subject matter jurisdiction….

District Court Refuses to Dismiss Indictment of Doctors for Prescribing Controlled Substances Over the Internet

U.S. District Judge Garcia-Gregory, in the District of Puerto Rico, denied a motion to dismiss an indictment charging seven doctors with violating the Controlled Substances Act by prescribing drugs over the internet without in-person examination of the customer-patient. The Court held that it was for the jury to decide whether the doctors' conduct exceeds the bounds of professional medical practice, rendering them criminally liable under §841, which prohibits the distribution of controlled substances by doctors when it is done "outside the scope of professional practice and not for a legitimate medical purpose." U.S. v. Rodriguez, Crim. No. 07-032(JAG) (D.P.R., October 24, 2007).

The defendants argued that Puerto Rico Telemedicine Regulating Act, Law No. 227 of August 11, 1998, 20 L.P.R.A. §6001 et seq., authorized them to practice telemedicine and, therefore, allowed them to prescribe controlled substances to their internet customers.

The case came before the Court on review of a Magistrate's Report and Recommendation, which concluded that the Telemedicine Law only authorizes the practice of telemedicine when both the physician and the patient are physically located in the Commonwealth of Puerto Rico. The Magistrate concluded that the "Defendants acted outside the scope of professional practice and not for a legitimate medical purpose when they carried out their telemedicine practice in several States other than Puerto Rico without having the proper licenses to do so in those jurisdictions." As characterized by the Court:

Defendants aver in their objections to the Magistrate-Judge's Report and Recommendation that the Superseding Indictment should be dismissed because they acted in conformity with the Telemedicine Law, which allegedly allows physicians to provide prescriptions to persons outside the geographical jurisdiction of the Commonwealth of Puerto Rico. Contrary to Magistrate-Judge Camille L. Velez-Rive's recommendation, Defendants allege that the Telemedicine Law made it unnecessary for them to obtain separate licenses from each of the States where the patients, who consulted them were located. According to Defendants, their conduct does not fall outside the scope of professional practice and constitutes a legitimate medical purpose.

The Court cited 21 U.S.C. § 841(a)(1), which makes it "unlawful for any person knowingly or intentionally… to manufacture, distribute, or dispense… a controlled substance." According to the Court, "although medical professionals are generally permitted to dispense controlled substances, they 'can be prosecuted under §841 when their activities fall outside the usual course of professional practice,'" quoting United States v. Moore, 423 U.S. 122, 124 (1975); United States v. Fuchs, 467 F.3d 889, 899 (5th Cir.2006).

The Court quotes from the Supreme Court decision in Moore, which states that "physicians who departed from the usual course of medical practice were subject to the same penalties as street pushers" and that Congress had intended the CSA to be more, not less, strict. Moore, 423 U.S. at 139. "Thus," according to the Court, "a physician is authorized to dispense controlled substances only if he acts with a legitimate medical purpose and in the usual course of professional practice." Nelson, 383 F.3d at 1233. "Conversely, a practitioner would be unauthorized to dispense a controlled substance if he acts without a legitimate medical purpose or outside the usual course of professional practice." Nelson, 383 F.3d at 1233. The Court noted that "the Courts of Appeal have upheld convictions of physicians and pharmacists for distributing controlled substances over the Internet," citing United States v. Fuchs, 467 F.3d 889 (5th Cir.2004); and United States v. Nelson, 383 F.3d 1227, 1232 (10th Cir.2006). According to the Court:

In prosecutions under §841 involving distribution of drugs that have been prescribed by a licensed physician, the Government is required to prove three elements: (1) that the defendant distributed a controlled substances, (2) that he or she acted intentionally and (3) that he or she prescribed the drug without a legitimate medical purpose and outside the course of professional practice. United States v. Feingold, 454 F.3d 1001, 1006 (9th Cir.2006); United States v. Johnson, 71 F.3d 539, 542 (6th Cir.1995); United States v. Tran Trong Cuong, 18 F.3d 1132, 1137 (4th Cir.1994); United States v. Varma, 691 F.2d 460, 462 (10th Cir.1982).

The Court emphasized that "the issue of whether a physician's conduct exceeds the bounds of professional medical practice, rendering him criminally liable under §841, is one for determination by a jury." Thus, "this is an element of the offense which the Government must prove to the jury, and is not properly the subject of a motion to dismiss." As characterized by the Court, "in essence, Defendants' objections are brought forth to achieve the dismissal of this case based on the theory that they acted with a legitimate medical purpose and in the usual course of professional practice." Defendants' arguments ignore the fact that the indictment in this case is not premised upon any statute or rule of law that specifically precludes the sale of prescription drugs over the Internet. It is, instead, premised upon a theory that the drugs were prescribed and distributed outside the bounds of professional medical practice. This is an element of the offense, which the Government must prove to the jury, and, therefore, is not properly the subject of a motion to dismiss. Consequently, Defendants' Motion to Dismiss must be denied.