128 S.Ct. 2109 (2008)

[2112] Maureen E. Mahoney, Washington, D.C., for petitioners.

Thomas G. Hungar, for the United States as amicus curiae, by special leave of the Court, supporting the petitioners.

Carter G. Phillips, Washington, D.C., for the respondent.

Terrence D. Garnett, Vincent K. Yip, Peter Wied, Paul, Hastings, Janofsky & Walker LLP, Los Angeles, CA, Maureen E. Mahoney, Counsel of Record, J. Scott Ballenger, Barry J. Blonien, Melissa B. Arbus, Anne W. Robinson, Latham & Watkins LLP, Washington, D.C., Maxwell A. Fox, Paul, Hastings, Janofsky & Walker LLP, Minato-Ku, Tokyo, for Petitioners.

Carter G. Phillips, Counsel of Record, Virginia A. Seitz, Jeffrey T. Green, Jeffrey P. Kushan, Rachel H. Townsend, Quin M. Sorenson, Sidley Austin LLP, Washington, D.C., for Respondent.

[2113] Justice THOMAS delivered the opinion of the Court.

For over 150 years this Court has applied the doctrine of patent exhaustion to limit the patent rights that survive the initial authorized sale of a patented item. In this case, we decide whether patent exhaustion applies to the sale of components of a patented system that must be combined with additional components in order to practice the patented methods. The Court of Appeals for the Federal Circuit held that the doctrine does not apply to method patents at all and, in the alternative, that it does not apply here because the sales were not authorized by the license agreement. We disagree on both scores. Because the exhaustion doctrine applies to method patents, and because the license authorizes the sale of components that substantially embody the patents in suit, the sale exhausted the patents.

I

Respondent LG Electronics, Inc. (LGE), purchased a portfolio of computer technology patents in 1999, including the three patents at issue here: U.S. Patent Nos. 4,939,641 ('641); 5,379,379 ('379); and 5,077,733 ('733) (collectively LGE Patents). The main functions of a computer system are carried out on a microprocessor, or central processing unit, which interprets program instructions, processes data, and controls other devices in the system. A set of wires, or bus, connects the microprocessor to a chipset, which transfers data between the microprocessor and other devices, including the keyboard, mouse, monitor, hard drive, memory, and disk drives.

The data processed by the computer are stored principally in random access memory, also called main memory. Webster's New World Dictionary of Computer Terms 334, 451 (8th ed.2000). Frequently accessed data are generally stored in cache memory, which permits faster access than main memory and is often located on the microprocessor itself. Id., at 84. When copies of data are stored in both the cache and main memory, problems may arise when one copy is changed but the other still contains the original "stale" version of the data. J. Handy, Cache Memory Book 124 (2d ed.1993). The '641 patent addresses this problem. It discloses a system for ensuring that the most current data are retrieved from main memory by monitoring data requests and updating main memory from the cache when stale data are requested. LG Electronics, Inc. v. Bizcom Electronics, Inc., 453 F.3d 1364, 1377 (C.A.Fed.2006).

The '379 patent relates to the coordination of requests to read from, and write to, main memory. Id., at 1378. Processing these requests in chronological order can slow down a system because read requests are faster to execute than write requests. Processing all read requests first ensures speedy access, but may result in the retrieval of outdated data if a read request for a certain piece of data is processed before an outstanding write request for the same data. The '379 patent discloses an efficient method of organizing read and write requests while maintaining accuracy by allowing the computer to execute only read requests until it needs data for which there is an outstanding write request. LG Electronics, Inc. v. Asustek Computer, Inc., No. C 01-02187 CW et al., Order Construing Disputed Terms and Phrases, p. 42 (ND Cal., Aug. 20, 2002). Upon receiving such a read request, the computer executes pending write requests first and only then returns to the read requests so that the most up-to-date data are retrieved. Ibid.

The '733 patent addresses the problem of managing the data traffic on a bus connecting two computer components, so [2114] that no one device monopolizes the bus. It allows multiple devices to share the bus, giving heavy users greater access. This patent describes methods that establish a rotating priority system under which each device alternately has priority access to the bus for a preset number of cycles and heavier users can maintain priority for more cycles without "hogging" the device indefinitely. Id., at 37-38.

LGE licensed a patent portfolio, including the LGE Patents, to Intel Corporation (Intel). The cross-licensing agreement (License Agreement) permits Intel to manufacture and sell microprocessors and chipsets that use the LGE Patents (the Intel Products). The License Agreement authorizes Intel to "`make, use, sell (directly or indirectly), offer to sell, import or otherwise dispose of'" its own products practicing the LGE Patents. Brief for Petitioners 8 (quoting App. 154).^[1] Notwithstanding this broad language, the License Agreement contains some limitations. Relevant here, it stipulates that no license

"`is granted by either party hereto . . . to any third party for the combination by a third party of Licensed Products of either party with items, components, or the like acquired . . . from sources other than a party hereto, or for the use, import, offer for sale or sale of such combination.'" Brief for Petitioners 8 (quoting App. 164).

The License Agreement purports not to alter the usual rules of patent exhaustion, however, providing that, "`[n]otwithstanding anything to the contrary contained in this Agreement, the parties agree that nothing herein shall in any way limit or alter the effect of patent exhaustion that would otherwise apply when a party hereto sells any of its Licensed Products.'" Brief for Petitioners 8 (quoting App. 164).

In a separate agreement (Master Agreement), Intel agreed to give written notice to its own customers informing them that, while it had obtained a broad license "`ensur[ing] that any Intel product that you purchase is licensed by LGE and thus does not infringe any patent held by LGE,'" the license "`does not extend, expressly or by implication, to any product that you make by combining an Intel product with any non-Intel product.'" Brief for Respondent 9 (emphasis deleted) (quoting App. 198). The Master Agreement also provides that "`a breach of this Agreement shall have no effect on and shall not be grounds for termination of the Patent License.'" Brief for Petitioners 9 (quoting App. 176).

Petitioners, including Quanta Computer (collectively Quanta), are a group of computer manufacturers. Quanta purchased microprocessors and chipsets from Intel and received the notice required by the Master Agreement. Nonetheless, Quanta manufactured computers using Intel parts in combination with non-Intel memory and buses in ways that practice the LGE Patents. Quanta does not modify the Intel components and follows Intel's specifications to incorporate the parts into its own systems.

LGE filed a complaint against Quanta, asserting that the combination of the Intel Products with non-Intel memory and buses infringed the LGE Patents. The District Court granted summary judgment to Quanta, holding that, for purposes of the patent exhaustion doctrine, the license LGE granted to Intel resulted in forfeiture of any potential infringement actions [2115] against legitimate purchasers of the Intel Products. LG Electronics, Inc. v. Asustek Computer, Inc., 65 USPQ 2d 1589, 1593, 1600 (N.D.Cal.2002). The court found that, although the Intel Products do not fully practice any of the patents at issue, they have no reasonable noninfringing use and therefore their authorized sale exhausted patent rights in the completed computers under United States v. Univis Lens Co., 316 U.S. 241, 62 S.Ct. 1088, 86 L.Ed. 1408 (1942). Asustek, supra, at 1598-1600. In a subsequent order limiting its summary judgment ruling, the court held that patent exhaustion applies only to apparatus or composition-of-matter claims that describe a physical object, and does not apply to process, or method, claims that describe operations to make or use a product. LG Electronics, Inc. v. Asustek Computer, Inc., 248 F.Supp.2d 912, 918 (N.D.Cal.2003). Because each of the LGE Patents includes method claims, exhaustion did not apply.

The Court of Appeals for the Federal Circuit affirmed in part and reversed in part. It agreed that the doctrine of patent exhaustion does not apply to method claims. In the alternative, it concluded that exhaustion did not apply because LGE did not license Intel to sell the Intel Products to Quanta for use in combination with non-Intel products. 453 F.3d, at 1370.

We granted certiorari, 551 U.S. ___, 128 S.Ct. 28, 168 L.Ed.2d 805 (2007).

II

The longstanding doctrine of patent exhaustion provides that the initial authorized sale of a patented item terminates all patent rights to that item. This Court first applied the doctrine in 19th-century cases addressing patent extensions on the Woodworth planing machine. Purchasers of licenses to sell and use the machine for the duration of the original patent term sought to continue using the licenses through the extended term. The Court held that the extension of the patent term did not affect the rights already secured by purchasers who bought the item for use "in the ordinary pursuits of life." Bloomer v. McQuewan, 14 How. 539, 549, 14 L.Ed. 532 (1853); see also ibid. ("[W]hen the machine passes to the hands of the purchaser, it is no longer within the limits of the monopoly"); Bloomer v. Millinger, 1 Wall. 340, 351, 17 L.Ed. 581 (1864). In Adams v. Burke, 17 Wall. 453, 21 L.Ed. 700 (1873), the Court affirmed the dismissal of a patent holder's suit alleging that a licensee had violated postsale restrictions on where patented coffin-lids could be used. "[W]here a person ha[s] purchased a patented machine of the patentee or his assignee," the Court held, "this purchase carrie[s] with it the right to the use of that machine so long as it [is] capable of use." Id., at 455.

Although the Court permitted postsale restrictions on the use of a patented article in Henry v. A.B. Dick Co., 224 U.S. 1, 32 S.Ct. 364, 56 L.Ed. 645 (1912),^[2] that [2116] decision was short lived. In 1913, the Court refused to apply A.B. Dick to uphold price-fixing provisions in a patent license. See Bauer & Cie v. O'Donnell, 229 U.S. 1, 14-17, 33 S.Ct. 616, 57 L.Ed. 1041 (1913). Shortly thereafter, in Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502, 518, 37 S.Ct. 416, 61 L.Ed. 871 (1917), the Court explicitly overruled A.B. Dick. In that case, a patent holder attempted to limit purchasers' use of its film projectors to show only film made under a patent held by the same company. The Court noted the "increasing frequency" with which patent holders were using A.B. Dick-style licenses to limit the use of their products and thereby using the patents to secure market control of related, unpatented items. 243 U.S., at 509, 516-517, 37 S.Ct. 416. Observing that "the primary purpose of our patent laws is not the creation of private fortunes for the owners of patents but is `to promote the progress of science and useful arts,'" id., at 511, 37 S.Ct. 416 (quoting U.S. Const., Art. I, § 8, cl. 8), the Court held that "the scope of the grant which may be made to an inventor in a patent, pursuant to the [patent] statute, must be limited to the invention described in the claims of his patent." 243 U.S., at 511, 37 S.Ct. 416. Accordingly, it reiterated the rule that "the right to vend is exhausted by a single, unconditional sale, the article sold being thereby carried outside the monopoly of the patent law and rendered free of every restriction which the vendor may attempt to put upon it." Id., at 516, 37 S.Ct. 416.

This Court most recently discussed patent exhaustion in Univis, 316 U.S. 241, 62 S.Ct. 1088, 86 L.Ed. 1408, on which the District Court relied. Univis Lens Company, the holder of patents on eyeglass lenses, licensed a purchaser to manufacture lens blanks^[3] by fusing together different lens segments to create bi- and tri-focal lenses and to sell them to other Univis licensees at agreed-upon rates. Wholesalers were licensed to grind the blanks into the patented finished lenses, which they would then sell to Univis-licensed prescription retailers for resale at a fixed rate. Finishing retailers, after grinding the blanks into patented lenses, would sell the finished lenses to consumers at the same fixed rate. The United States sued Univis under the Sherman Act, 15 U.S.C. §§ 1, 3, 15, alleging unlawful restraints on trade. Univis asserted its patent monopoly rights as a defense to the antitrust suit. The Court granted certiorari to determine whether Univis' patent monopoly survived the sale of the lens blanks by the licensed manufacturer and therefore shielded Univis' pricing scheme from the Sherman Act.

The Court assumed that the Univis patents containing claims for finished lenses were practiced in part by the wholesalers and finishing retailers who ground the blanks into lenses, and held that the sale of the lens blanks exhausted the patents on the finished lenses. Univis, 316 U.S., at 248-249, 62 S.Ct. 1088. The Court explained that the lens blanks "embodi[ed] essential features of the patented device and [were] without utility until . . . ground and polished as the finished lens of the patent." Id., at 249, 62 S.Ct. 1088. The Court noted that:

"where one has sold an uncompleted article which, because it embodies essential features of his patented invention, is within the protection of his patent, and has destined the article to be finished by the purchaser in conformity to the patent, he has sold his invention so far as it [2117] is or may be embodied in that particular article." Id., at 250-251, 62 S.Ct. 1088.

In sum, the Court concluded that the traditional bar on patent restrictions following the sale of an item applies when the item sufficiently embodies the patent— even if it does not completely practice the patent—such that its only and intended use is to be finished under the terms of the patent.

With this history of the patent exhaustion doctrine in mind, we turn to the parties' arguments.

III

A

LGE argues that the exhaustion doctrine is inapplicable here because it does not apply to method claims, which are contained in each of the LGE Patents. LGE reasons that, because method patents are linked not to a tangible article but to a process, they can never be exhausted through a sale. Rather, practicing the patent—which occurs upon each use of an article embodying a method patent—is permissible only to the extent rights are transferred in an assignment contract. Quanta, in turn, argues that there is no reason to preclude exhaustion of method claims, and points out that both this Court and the Federal Circuit have applied exhaustion to method claims. It argues that any other rule would allow patent holders to avoid exhaustion entirely by inserting method claims in their patent specifications.

Quanta has the better of this argument. Nothing in this Court's approach to patent exhaustion supports LGE's argument that method patents cannot be exhausted. It is true that a patented method may not be sold in the same way as an article or device, but methods nonetheless may be "embodied" in a product, the sale of which exhausts patent rights. Our precedents do not differentiate transactions involving embodiments of patented methods or processes from those involving patented apparatuses or materials. To the contrary, this Court has repeatedly held that method patents were exhausted by the sale of an item that embodied the method. In Ethyl Gasoline Corp. v. United States, 309 U.S. 436, 446, 457, 60 S.Ct. 618, 84 L.Ed. 852 (1940), for example, the Court held that the sale of a motor fuel produced under one patent also exhausted the patent for a method of using the fuel in combustion motors.^[4] Similarly, as previously described, Univis held that the sale of optical lens blanks that partially practiced a patent exhausted the method patents that were not completely practiced until the blanks were ground into lenses. 316 U.S., at 248-251, 62 S.Ct. 1088.

These cases rest on solid footing. Eliminating exhaustion for method patents would seriously undermine the exhaustion doctrine. Patentees seeking to avoid patent exhaustion could simply draft their patent claims to describe a method rather than an apparatus.^[5] Apparatus and method [2118] claims "may approach each other so nearly that it will be difficult to distinguish the process from the function of the apparatus." United States ex rel. Steinmetz v. Allen, 192 U.S. 543, 559, 24 S.Ct. 416, 48 L.Ed. 555 (1904). By characterizing their claims as method instead of apparatus claims, or including a method claim for the machine's patented method of performing its task, a patent drafter could shield practically any patented item from exhaustion.

This case illustrates the danger of allowing such an end-run around exhaustion. On LGE's theory, although Intel is authorized to sell a completed computer system that practices the LGE Patents, any downstream purchasers of the system could nonetheless be liable for patent infringement. Such a result would violate the longstanding principle that, when a patented item is "once lawfully made and sold, there is no restriction on [its] use to be implied for the benefit of the patentee." Adams, 17 Wall., at 457, 21 L.Ed. 700. We therefore reject LGE's argument that method claims, as a category, are never exhaustible.

B

We next consider the extent to which a product must embody a patent in order to trigger exhaustion. Quanta argues that, although sales of an incomplete article do not necessarily exhaust the patent in that article, the sale of the microprocessors and chipsets exhausted LGE's patents in the same way the sale of the lens blanks exhausted the patents in Univis. Just as the lens blanks in Univis did not fully practice the patents at issue because they had not been ground into finished lenses, Quanta observes, the Intel Products cannot practice the LGE Patents—or indeed, function at all—until they are combined with memory and buses in a computer system. If, as in Univis, patent rights are exhausted by the sale of the incomplete item, then LGE has no postsale right to require that the patents be practiced using only Intel parts. Quanta also argues that exhaustion doctrine will be a dead letter unless it is triggered by the sale of components that essentially, even if not completely, embody an invention. Otherwise, patent holders could authorize the sale of computers that are complete with the exception of one minor step—say, inserting the microprocessor into a socket— and extend their rights through each downstream purchaser all the way to the end user.

LGE, for its part, argues that Univis is inapplicable here for three reasons. First, it maintains that Univis should be limited to products that contain all the physical aspects needed to practice the patent. On that theory, the Intel Products cannot embody the patents because additional physical components are required before the patents can be practiced. Second, LGE asserts that in Univis there was no "patentable distinction" between the lens blanks and the patented finished lenses since they were both subject to the same patent. Brief for Respondent 14 (citing Univis, supra, at 248-252, 62 S.Ct. 1088). In contrast, it describes the Intel Products as "independent and distinct products" from the systems using the LGE Patents and subject to "independent patents." Brief for Respondent 13. Finally, LGE argues that Univis does not apply because the Intel Products are analogous to individual elements of a combination patent, [2119] and allowing sale of those components to exhaust the patent would impermissibly "ascrib[e] to one element of the patented combination the status of the patented invention in itself." Aro Mfg. Co. v. Convertible Top Replacement Co., 365 U.S. 336, 344-345, 81 S.Ct. 599, 5 L.Ed.2d 592 (1961).

We agree with Quanta that Univis governs this case. As the Court there explained, exhaustion was triggered by the sale of the lens blanks because their only reasonable and intended use was to practice the patent and because they "embodie[d] essential features of [the] patented invention." 316 U.S., at 249-251, 62 S.Ct. 1088. Each of those attributes is shared by the microprocessors and chipsets Intel sold to Quanta under the License Agreement.

First, Univis held that "the authorized sale of an article which is capable of use only in practicing the patent is a relinquishment of the patent monopoly with respect to the article sold." Id., at 249, 62 S.Ct. 1088. The lens blanks in Univis met this standard because they were "without utility until [they were] ground and polished as the finished lens of the patent." Ibid. Accordingly, "the only object of the sale [was] to enable the [finishing retailer] to grind and polish it for use as a lens by the prospective wearer." Ibid. Here, LGE has suggested no reasonable use for the Intel Products other than incorporating them into computer systems that practice the LGE Patents.^[6] Nor can we can discern one: A microprocessor or chipset cannot function until it is connected to buses and memory. And here, as in Univis, the only apparent object of Intel's sales to Quanta was to permit Quanta to incorporate the Intel Products into computers that would practice the patents.

Second, the lens blanks in Univis "embodie[d] essential features of [the] patented invention." Id., at 250-251, 62 S.Ct. 1088. The essential, or inventive, feature of the Univis lens patents was the fusing together of different lens segments to create bi- and tri-focal lenses. The finishing process performed by the finishing and prescription retailers after the fusing was not unique. As the United States explained:

"The finishing licensees finish Univis lens blanks in precisely the same manner as they finish all other bifocal lens blanks. Indeed, appellees have never contended that their licensing system is supported by patents covering methods or processes relating to the finishing of lens blanks. Consequently, it appears that appellees perform all of the operations which contribute any claimed element of novelty to Univis lenses." Brief for United States in United States v. Univis Lens Co., O.T.1941, No. 855 et al., p. 10 (footnote and citations omitted).

While the Court assumed that the finishing process was covered by the patents, Univis, supra, at 248-249, 62 S.Ct. 1088, and the District Court found that it was necessary to make a working lens, United States v. Univis Lens Co., 41 F.Supp. 258, 262-263 (S.D.N.Y.1941), the grinding process [2120] was not central to the patents. That standard process was not included in detail in any of the patents and was not referred to at all in two of the patents. Those that did mention the finishing process treated it as incidental to the invention, noting, for example, that "[t]he blank is then ground in the usual manner," U.S. Patent No. 1,876,497, p. 2, or simply that the blank is "then ground and polished," U.S. Patent No. 1,632,208, p. 1, Tr. of Record in United States v. Univis Lens Co., O.T.1941, No. 855 et al., pp. 516, 498.

Like the Univis lens blanks, the Intel Products constitute a material part of the patented invention and all but completely practice the patent. Here, as in Univis, the incomplete article substantially embodies the patent because the only step necessary to practice the patent is the application of common processes or the addition of standard parts. Everything inventive about each patent is embodied in the Intel Products. They control access to main and cache memory, practicing the '641 and '379 patents by checking cache memory against main memory and comparing read and write requests. They also control priority of bus access by various other computer components under the '733 patent. Naturally, the Intel Products cannot carry out these functions unless they are attached to memory and buses, but those additions are standard components in the system, providing the material that enables the microprocessors and chipsets to function. The Intel Products were specifically designed to function only when memory or buses are attached; Quanta was not required to make any creative or inventive decision when it added those parts. Indeed, Quanta had no alternative but to follow Intel's specifications in incorporating the Intel Products into its computers because it did not know their internal structure, which Intel guards as a trade secret. Brief for Petitioners 3. Intel all but practiced the patent itself by designing its products to practice the patents, lacking only the addition of standard parts.

We are unpersuaded by LGE's attempts to distinguish Univis. First, there is no reason to distinguish the two cases on the ground that the articles in Univis required the removal of material to practice the patent while the Intel Products require the addition of components to practice the patent. LGE characterizes the lens blanks and lenses as sharing a "basic nature" by virtue of their physical similarity, while the Intel Products embody only some of the "patentably distinct elements and steps" involved in the LGE Patents. Brief for Respondent 26-27. But we think that the nature of the final step, rather than whether it consists of adding or deleting material, is the relevant characteristic. In each case, the final step to practice the patent is common and noninventive: grinding a lens to the customer's prescription, or connecting a microprocessor or chipset to buses or memory. The Intel Products embody the essential features of the LGE Patents because they carry out all the inventive processes when combined, according to their design, with standard components.

With regard to LGE's argument that exhaustion does not apply across patents, we agree on the general principle: The sale of a device that practices patent A does not, by virtue of practicing patent A, exhaust patent B. But if the device practices patent A while substantially embodying patent B, its relationship to patent A does not prevent exhaustion of patent B. For example, if the Univis lens blanks had been composed of shatter-resistant glass under patent A, the blanks would nonetheless have substantially embodied, and therefore exhausted, patent B for the finished lenses. This case is no different. [2121] While each Intel microprocessor and chipset practices thousands of individual patents, including some LGE patents not at issue in this case, the exhaustion analysis is not altered by the fact that more than one patent is practiced by the same product. The relevant consideration is whether the Intel Products that partially practice a patent—by, for example, embodying its essential features—exhaust that patent.

Finally, LGE's reliance on Aro is misplaced because that case dealt only with the question whether replacement of one part of a patented combination infringes the patent. First, the replacement question is not at issue here. Second, and more importantly, Aro is not squarely applicable to the exhaustion of patents like the LGE Patents that do not disclose a new combination of existing parts. Aro described combination patents as "cover[ing] only the totality of the elements in the claim [so] that no element, separately viewed, is within the grant." 365 U.S., at 344, 81 S.Ct. 599; see also Mercoid Corp. v. Mid-Continent Investment Co., 320 U.S. 661, 667-668, 64 S.Ct. 268, 88 L.Ed. 376 (1944) (noting that, in a combination patent, "the combination is the invention and it is distinct from any" of its elements). Aro's warning that no element can be viewed as central to or equivalent to the invention is specific to the context in which the combination itself is the only inventive aspect of the patent. In this case, the inventive part of the patent is not the fact that memory and buses are combined with a microprocessor or chipset; rather, it is included in the design of the Intel Products themselves and the way these products access the memory or bus.

C

Having concluded that the Intel Products embodied the patents, we next consider whether their sale to Quanta exhausted LGE's patent rights. Exhaustion is triggered only by a sale authorized by the patent holder. Univis, 316 U.S., at 249, 62 S.Ct. 1088.

LGE argues that there was no authorized sale here because the License Agreement does not permit Intel to sell its products for use in combination with non-Intel products to practice the LGE Patents. It cites General Talking Pictures Corp. v. Western Elec. Co., 304 U.S. 175, 58 S.Ct. 849, 82 L.Ed. 1273 (1938), and General Talking Pictures Corp. v. Western Elec. Co., 305 U.S. 124, 59 S.Ct. 116, 83 L.Ed. 81 (1938), in which the manufacturer sold patented amplifiers for commercial use, thereby breaching a license that limited the buyer to selling the amplifiers for private and home use. The Court held that exhaustion did not apply because the manufacturer had no authority to sell the amplifiers for commercial use, and the manufacturer "could not convey to petitioner what both knew it was not authorized to sell." General Talking Pictures, supra, at 181, 58 S.Ct. 849. LGE argues that the same principle applies here: Intel could not convey to Quanta what both knew it was not authorized to sell, i.e., the right to practice the patents with non-Intel parts.

LGE overlooks important aspects of the structure of the Intel-LGE transaction. Nothing in the License Agreement restricts Intel's right to sell its microprocessors and chipsets to purchasers who intend to combine them with non-Intel parts. It broadly permits Intel to "`make, use, [or] sell'" products free of LGE's patent claims. Brief for Petitioners 8 (quoting App. 154). To be sure, LGE did require Intel to give notice to its customers, including Quanta, that LGE had not licensed those customers to practice its patents. But neither party contends that Intel breached the agreement in that respect. Brief for Petitioners 9; Brief for Respondent 9. In any event, the provision requiring [2122] notice to Quanta appeared only in the Master Agreement, and LGE does not suggest that a breach of that agreement would constitute a breach of the License Agreement. Hence, Intel's authority to sell its products embodying the LGE Patents was not conditioned on the notice or on Quanta's decision to abide by LGE's directions in that notice.

LGE points out that the License Agreement specifically disclaimed any license to third parties to practice the patents by combining licensed products with other components. Brief for Petitioners 8. But the question whether third parties received implied licenses is irrelevant because Quanta asserts its right to practice the patents based not on implied license but on exhaustion. And exhaustion turns only on Intel's own license to sell products practicing the LGE Patents.

Alternatively, LGE invokes the principle that patent exhaustion does not apply to postsale restrictions on "making" an article. Brief for Respondent 43. But this is simply a rephrasing of its argument that combining the Intel Products with other components adds more than standard finishing to complete a patented article. As explained above, making a product that substantially embodies a patent is, for exhaustion purposes, no different from making the patented article itself. In other words, no further "making" results from the addition of standard parts—here, the buses and memory—to a product that already substantially embodies the patent.

The License Agreement authorized Intel to sell products that practiced the LGE Patents. No conditions limited Intel's authority to sell products substantially embodying the patents. Because Intel was authorized to sell its products to Quanta, the doctrine of patent exhaustion prevents LGE from further asserting its patent rights with respect to the patents substantially embodied by those products.^[7]

IV

The authorized sale of an article that substantially embodies a patent exhausts the patent holder's rights and prevents the patent holder from invoking patent law to control postsale use of the article. Here, LGE licensed Intel to practice any of its patents and to sell products practicing those patents. Intel's microprocessors and chipsets substantially embodied the LGE Patents because they had no reasonable noninfringing use and included all the inventive aspects of the patented methods. Nothing in the License Agreement limited Intel's ability to sell its products practicing the LGE Patents. Intel's authorized sale to Quanta thus took its products outside the scope of the patent monopoly, and as a result, LGE can no longer assert its patent rights against Quanta. Accordingly, the judgment of the Court of Appeals is reversed.

It is so ordered.

[1] App. 145-198 is sealed; where material contained therein also appears in the parties' unsealed briefs, citations are to the latter.

[2] The A.B. Dick Company sold mimeograph machines with an attached license stipulating that the machine could be used only with ink, paper, and other supplies made by the A.B. Dick Company. The Court rejected the notion that a patent holder "can only keep the article within the control of the patent by retaining the title," A.B. Dick, 224 U.S., at 18, 32 S.Ct. 364, and held that "any . . . reasonable stipulation, not inherently violative of some substantive law" was "valid and enforceable," id., at 31, 32 S.Ct. 364. The only requirement, the Court held, was that "the purchaser must have notice that he buys with only a qualified right of use," so that a sale made without conditions resulted in "an unconditional title to the machine, with no limitations upon the use." Id., at 26, 32 S.Ct. 364.

[3] Lens blanks are "rough opaque pieces of glass of suitable size, design and composition for use, when ground and polished, as multi-focal lenses in eyeglasses." Univis, 316 U.S., at 244, 62 S.Ct. 1088.

[4] The patentee held patents for (1) a fluid additive increasing gasoline efficiency, (2) motor fuel produced by mixing gasoline with the patented fluid, and (3) a method of using fuel containing the patented fluid in combustion motors. Ethyl Gasoline Corp., 309 U.S., at 446, 60 S.Ct. 618. The patentee sold only the fluid, but attempted to control sales of the treated fuel. Id., at 459, 60 S.Ct. 618. The Court held that the sale of the fluid to refiners relinquished the patentee's exclusive rights to sell the treated fuel. Id., at 457, 60 S.Ct. 618.

[5] One commentator recommends this strategy as a way to draft patent claims that "will survive numerous transactions regarding the patented good, allowing the force of the patent to intrude deeply into the stream of commerce." Thomas, Of Text, Technique, and the Tangible: Drafting Patent Claims Around Patent Rules, 17 J. Marshall J. Computer & Info. L. 219, 252 (1998); see also id., at 225-226 (advocating the conversion of apparatus claims into method claims and noting that "[e]ven the most novice claims drafter would encounter scant difficulty in converting a patent claim from artifact to technique and back again").

[6] LGE suggests that the Intel Products would not infringe its patents if they were sold overseas, used as replacement parts, or engineered so that use with non-Intel Products would disable their patented features. Brief for Respondent 21-22, n. 10. But Univis teaches that the question is whether the product is "capable of use only in practicing the patent," not whether those uses are infringing. 316 U.S., at 249, 62 S.Ct. 1088 (emphasis added). Whether outside the country or functioning as replacement parts, the Intel Products would still be practicing the patent, even if not infringing it. And since the features partially practicing the patent are what must have an alternative use, suggesting that they be disabled is no solution. The disabled features would have no real use.

[7] We note that the authorized nature of the sale to Quanta does not necessarily limit LGE's other contract rights. LGE's complaint does not include a breach-of-contract claim, and we express no opinion on whether contract damages might be available even though exhaustion operates to eliminate patent damages. See Keeler v. Standard Folding Bed Co., 157 U.S. 659, 666, 15 S.Ct. 738, 39 L.Ed. 848 (1895) ("Whether a patentee may protect himself and his assignees by special contracts brought home to the purchasers is not a question before us, and upon which we express no opinion. It is, however, obvious that such a question would arise as a question of contract, and not as one under the inherent meaning and effect of the patent laws").

541 F.3d 982 (2008)

Nos. 07-55368, 07-56206.

Argued and Submitted July 15, 2008.
Filed September 3, 2008.

[983] Barry R. Levy and Andrea M. Gauthier, Horvitz & Levy LLP, Encino, CA; David S. Richman and Kenneth E. Johnson, Theodora Oringher Miller & Richman, P.C., Los Angeles, CA; and Matthew C. Wagner, Jess M. Collen, Thomas P. Gulick, Collen IP, Ossining, NY, for the plaintiff-appellant.

Aaron J. Moss and Norman H. Levine, Greenberg Glusker Fields Claman & Machtinger LLP, Los Angeles, CA, for the defendant-appellee.

W. Stephen Cannon and Seth D. Greenstein, Constantine Cannon LLP, Washington, D.C., for the amici curiae.

Before: BARRY G. SILVERMAN, JOHNNIE B. RAWLINSON, and MILAN D. SMITH, JR., Circuit Judges.

MILAN D. SMITH, JR., Circuit Judge:

In this opinion, we address whether the Supreme Court's decision in Quality King Distributors, Inc. v. L'anza Research International, Inc., 523 U.S. 135, 118 S.Ct. 1125, 140 L.Ed.2d 254 (1998), requires us to overrule our precedents that allow a defendant in a copyright infringement action to claim the "first sale doctrine" of 17 U.S.C. § 109(a) as a defense only where the disputed copies of a copyrighted work were either made or previously sold in the United States with the authority of the copyright owner. Plaintiff-Appellant Omega S.A. (Omega) filed claims for infringing distribution and importation under 17 U.S.C. §§ 106(3) and 602(a) in response to Defendant-Appellee Costco Wholesale Corporation's (Costco) unauthorized sale of authentic, imported Omega watches bearing a design registered at the U.S. Copyright Office. The district court granted summary judgment to Costco on the basis of the first sale doctrine, and awarded attorney's fees. We have jurisdiction pursuant to 28 U.S.C. § 1291, and we reverse.

This circuit has construed 17 U.S.C. § 109(a) to provide no defense to an infringement action under §§ 106(3) and 602(a) that involves (1) foreign-made, nonpiratical copies of a U.S.-copyrighted work, (2) unless those same copies have already been sold in the United States with the copyright owner's authority. We hold that the first portion of this construction is not "clearly irreconcilable" with Quality King, and that it remains the law of this circuit. See Miller v. Gammie, 335 F.3d 889, 900 (9th Cir.2003) (en banc). Because there is no genuine dispute that Omega made the copies of the disputed design in Switzerland, and that Costco sold them in the United States without Omega's authority, the first sale doctrine is unavailable as a defense to Omega's claims.

I. FACTUAL AND PROCEDURAL BACKGROUND

The facts are not disputed. Omega manufactures watches in Switzerland and sells them globally through a network of authorized distributors and retailers. Engraved on the underside of the watches is a U.S.-copyrighted "Omega Globe Design."

[984] Costco obtained watches bearing the copyrighted design from the "gray market"^[1] in the following manner: Omega first sold the watches to authorized distributors overseas. Unidentified third parties eventually purchased the watches and sold them to ENE Limited, a New York company, which in turn sold them to Costco. Costco then sold the watches to consumers in California. Although Omega authorized the initial foreign sale of the watches, it did not authorize their importation into the United States or the sales made by Costco.

Omega filed a lawsuit alleging that Costco's acquisition and sale of the watches constitute copyright infringement under 17 U.S.C. §§ 106(3) and 602(a), and subsequently moved for summary judgment. Costco filed a cross-motion on the basis of 17 U.S.C. § 109(a), arguing that, under the first sale doctrine, Omega's initial foreign sale of the watches precludes claims of infringing distribution and importation in connection with the subsequent, unauthorized sales. The district court ruled without explanation in favor of Costco on both motions. The court also awarded $373,003.80 in attorney's fees to Costco under 17 U.S.C. § 505. This appeal followed.

II. STANDARD OF REVIEW

We review de novo a district court's grant of summary judgment under Federal Rule of Civil Procedure 56. Buono v. Norton, 371 F.3d 543, 545 (9th Cir.2004). Rule 56(c) provides that summary judgment is warranted when the "pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law." We review a district court's award of attorney's fees under 17 U.S.C. § 505 for an abuse of discretion. Columbia Pictures Television, Inc. v. Krypton Broad. of Birmingham, Inc., 259 F.3d 1186, 1197 (9th Cir.2001).

III. DISCUSSION

The viability of Omega's infringement claims hinges on the relationship among three sections of the Copyright Act of 1976: 17 U.S.C. §§ 106(3), 109(a), and 602(a). In relevant part, § 602(a) reads:

Importation 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, actionable under section 501.^[2]

Section 106(3) states:

Subject to sections 107 through 122, the owner of copyright under this title has the exclusive rights ... to distribute copies ... of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending.

Finally, § 109(a) provides:

Notwithstanding the provisions of section 106(3), the owner of a particular [985] copy ... 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....

This last section codifies the so-called "first sale doctrine," which holds that "[o]nce [a] copyright owner consents to the sale of particular copies of his work, he may not thereafter exercise the distribution right with respect to those copies." 2-8 Melville B. Nimmer & David Nimmer, Nimmer on Copyright § 8.12(B)(1), at 8-156 (1978 ed.).

The text of the Copyright Act establishes by syllogism that the first sale doctrine of § 109(a) limits § 602(a): First, given that § 106(3) is "subject to sections 107 through 122" and § 109 falls within the designated portion of the Code, § 109(a) limits the exclusive distribution right in § 106(3). Second, infringing importation under § 602(a) is merely a subcategory of "infringement of the exclusive right to distribute copies ... under section 106," so conduct that does not violate § 106(3) cannot constitute infringement under § 602(a). Finally, because conduct covered by § 109(a) does not violate § 106(3), and because absent a violation of § 106(3) there cannot be infringement under § 602(a), conduct covered by § 109(a) does not violate § 602(a). In short, infringement does not occur under § 106(3) or § 602(a) where "the owner of a particular copy ... lawfully made under this title" imports and sells that copy without the authority of the copyright owner. 17 U.S.C. § 109(a);^[3] see Quality King Distribs., Inc. v. L'anza Res. Int'l, Inc., 523 U.S. 135, 144-45, 118 S.Ct. 1125, 140 L.Ed.2d 254 (1998) (adopting this interpretation).

Omega concedes that § 109(a) generally limits §§ 106(3) and 602(a), but contends that § 109(a) does not apply in this case. Specifically, Omega argues that § 109(a) provides no defense to the infringement claims because, although the Omega Globe Design was copyrighted in the United States, the watches bearing the design were manufactured and first sold overseas. Omega claims that the copies of the design were not "lawfully made under [Title 17]" in these circumstances. 17 U.S.C. § 109(a). Costco responds that although Omega's position is correct under BMG Music v. Perez, 952 F.2d 318 (9th Cir.1991), Parfums Givenchy, Inc. v. Drug Emporium, Inc., 38 F.3d 477 (9th Cir. 1994), and Denbicare U.S.A. Inc. v. Toys "R" Us, Inc., 84 F.3d 1143 (9th Cir.1996), the Supreme Court effectively overruled those cases in Quality King, 523 U.S. 135, 118 S.Ct. 1125. For the reasons set forth below, we hold that Quality King did not invalidate our general rule that § 109(a) can provide a defense against §§ 106(3) and 602(a) claims only insofar as the claims involve domestically made copies of U.S.-copyrighted works. Because we also conclude that the exception to that rule does not apply, § 109(a) provides no defense in this case.

A. Current Rule in the Circuit

Omega's position was clearly correct under pre-Quality King Ninth Circuit precedent. This court has twice held on indistinguishable facts that § 109(a) provides no defense against a claim under § 602(a). In BMG Music, the defendant purchased copies of the plaintiffs' U.S.-copyrighted, foreign-manufactured sound recordings, imported them into the United States without the plaintiffs' authorization, and [986] then sold them to the public. 952 F.2d at 319. Following CBS v. Scorpio Music Distributors, 569 F.Supp. 47, 49 (E.D.Pa. 1983), aff'd without opinion, 738 F.2d 424 (3d Cir.1984), we held that § 109(a) provided no defense against a claim under § 602(a) in the circumstances because the phrase "lawfully made under this title" in § 109(a) "grants first sale protection only to copies legally made and sold in the United States," and the copies at issue were made and first sold abroad. 952 F.2d at 319. The rationale for this interpretation was twofold: First, a contrary interpretation would impermissibly extend the Copyright Act extraterritorially. Id. (citing Scorpio, 569 F.Supp. at 49). Second, the application of § 109(a) after foreign sales would "`render § 602 virtually meaningless'" as a tool against the unauthorized importation of nonpiratical copies because importation is almost always preceded by at least one lawful foreign sale that will have exhausted the distribution right on which § 602(a) is premised. Id. at 319-20 (quoting Scorpio, 569 F.Supp. at 49).

Drug Emporium, 38 F.3d 477, followed BMG Music by holding on similar material facts that § 109(a) provided no defense. However, we criticized the prior interpretation of § 109(a)'s key phrase—"lawfully made under this title." By permitting the first sale defense only against claims involving copies that are "legally made and sold in the United States," BMG Music appeared to give greater copyright protection to foreign-made copies than to their domestically made counterparts. See 38 F.3d at 482 n. 8. We found that "such a result would be untenable, and that nothing in the legislative history or text of § 602 supports such an interpretation." Id.; see also 2 Paul Goldstein, Goldstein on Copyright § 7.6.1, at 142 (3d ed.2007) (criticizing the approach in BMG Music and Scorpio). We therefore created an exception to BMG Music, concluding that § 109(a) can apply to copies not made in the United States so long as an authorized first sale occurs here. Drug Emporium, 38 F.3d at 481.

Denbicare, which involved copies made in Hong Kong and voluntarily sold by the U.S. copyright owner within the United States, applied the exception created by Drug Emporium. Denbicare, 84 F.3d at 1145-46. The copyright owner sued under §§ 106(3) and 602(a) after the defendant purchased the copies and resold them without permission, but we rejected the claims: The defendant was not liable for infringing importation under § 602(a) because the disputed copies were imported by third parties prior to the defendant's purchase and resale. Id. at 1149. The defendant also was not liable under § 106(3) because, in light of § 109(a) and Drug Emporium, the copyright owner's voluntary sale of the copies within the United States exhausted the exclusive right of distribution. Id. at 1149-50.

Under these cases, Costco would not be entitled to summary judgment on the basis of § 109(a). The statute would not apply because Omega made copies of the Omega Globe Design in Switzerland and Costco sold the copies without Omega's authority in the United States. The district court's unexplained grant of summary judgment on the basis of § 109(a) was at odds with BMG Music, Drug Emporium, and Denbicare.^[4]

[987] B. The Impact of Quality King

We next address the degree to which the Supreme Court's decision in Quality King invalidates this circuit's construction of § 109(a). This panel may overrule BMG Music, Drug Emporium, and Denbicare if Quality King "undercut[s] the theory or reasoning underlying the prior circuit precedent in such a way that the cases are clearly irreconcilable." Miller, 335 F.3d at 900.

1.

It is clear that Quality King did not directly overrule BMG Music, Drug Emporium, and Denbicare. Quality King involved "round trip" importation: a product with a U.S.-copyrighted label was manufactured inside the United States, exported to an authorized foreign distributor, sold to unidentified third parties overseas, shipped back into the United States without the copyright owner's permission, and then sold in California by unauthorized retailers. 523 U.S. at 138-39, 118 S.Ct. 1125. The Court held that § 109(a) can provide a defense to an action under § 602(a) in this context. Id. at 144-52, 118 S.Ct. 1125. However, because the facts involved only domestically manufactured copies, the Court did not address the effect of § 109(a) on claims involving unauthorized importation of copies made abroad. See id. at 154, 118 S.Ct. 1125 (Ginsburg, J., concurring) ("[W]e do not today resolve cases in which the allegedly infringing imports were manufactured abroad."). Moreover, the Court never discussed the scope of § 109(a) or defined what "lawfully made under this title" means.

2.

We next consider whether the reasoning^[5] of Quality King is clearly irreconcilable with our general rule that § 109(a) is limited to copies "legally made ... in the United States." BMG Music, 952 F.2d at 319; see also Denbicare, 84 F.3d at 1150. The basis for that rule was our concern that applying § 109(a) to foreign-made copies would violate the presumption against the extraterritorial application of U.S. law. BMG Music, 952 F.2d at 319 (citing Scorpio, 569 F.Supp. at 49); cf. Subafilms, Ltd. v. MGM-Pathe Commc'ns Co., 24 F.3d 1088, 1093-98 (9th Cir.1994) (en banc) (describing the "undisputed axiom" that United States copyright law has no extraterritorial application). Quality King dismissed a similar concern that the triggering of § 109(a) by foreign sales would require an invalid extraterritorial application of the Copyright Act, explaining that merely recognizing the occurrence of such sales "does not require the extraterritorial application of the Act any more than § 602(a)'s `acquired abroad' language does." 523 U.S. at 145 n. 14, 118 S.Ct. 1125. Costco contends that this explanation is irreconcilable with our interpretation of § 109(a) in BMG Music.

We reject Costco's contention and hold that the Supreme Court's brief discussion on extraterritoriality is not "clearly irreconcilable" with our general limitation of § 109(a) to copies that are lawfully made in the United States. Miller, 335 F.3d at 900. The common understanding of the presumption against extraterritoriality is that a U.S. statute "appl[ies] only to conduct occurring within, or having effect [988] within, the territory of the United States, unless the contrary is clearly indicated by the statute." Restatement (Second) of Foreign Relations Law of the United States § 38 (1965); see also EEOC v. Arabian Am. Oil Co., 499 U.S. 244, 248, 111 S.Ct. 1227, 113 L.Ed.2d 274 (1991). Recognizing the importance of avoiding international conflicts of law in the area of intellectual property, however, we have applied a more robust version of this presumption to the Copyright Act, holding that the Act presumptively does not apply to conduct that occurs abroad even when that conduct produces harmful effects within the United States. See Subafilms, Ltd., 24 F.3d at 1096-98; see also William S. Dodge, Understanding the Presumption Against Extraterritoriality, 16 Berkeley J. Int'l L. 85, 101 (1998) (characterizing this circuit's approach under the Copyright Act as consistent with American Banana Co. v. United Fruit Co., 213 U.S. 347, 356, 29 S.Ct. 511, 53 L.Ed. 826 (1909), overruled on other grounds, Continental Ore Co. v. Union Carbide & Carbon Corp., 370 U.S. 690, 704-05, 82 S.Ct. 1404, 8 L.Ed.2d 777 (1962), which described the presumption as a "general and almost universal rule ... that the character of an act as lawful or unlawful must be determined wholly by the law of the country where the act is done").

Given this understanding of the presumption, the application of § 109(a) to foreign-made copies would impermissibly apply the Copyright Act extraterritorially in a way that the application of the statute after foreign sales does not. Under the latter application, the statute merely acknowledges the occurrence of a foreign event as a relevant fact. The former application would go much further. To characterize the making of copies overseas as "lawful[ ] ... under [Title 17]" would be to ascribe legality under the Copyright Act to conduct that occurs entirely outside the United States, notwithstanding the absence of a clear expression of congressional intent in favor of extraterritoriality. See 17 U.S.C. § 109(a); see also Subafilms, Ltd., 24 F.3d at 1096 ("There is no clear expression of congressional intent in either the 1976 Act or other relevant enactments to alter the preexisting extraterritoriality doctrine."). Specifically, it would mean that a copyright owner's foreign manufacturing constitutes lawful reproduction under 17 U.S.C. § 106(1) even though that statute does not clearly provide for extraterritorial application. This is precisely what we proscribed in Subafilms, see 24 F.3d at 1098, and Quality King provides no basis for rejecting our approach.

Other significant parts of Quality King's analysis are also consistent with BMG Music's limitation of § 109(a) to domestically made copies. The Court found that copies of a work copyrighted under Title 17 are not necessarily "lawfully made under [Title 17]" even when made by the owner of the copyright: The category of copies covered by § 602(a), it was explained, encompasses "copies that were `lawfully made' not under the United States Copyright Act, but instead, under the law of some other country." 523 U.S. at 147, 118 S.Ct. 1125. Because § 602(a) extends to such copies, but on its terms permits an infringement action only by the "owner of copyright under [Title 17]," copies of a work can be lawfully made "under the law of some other country," rather than "under[Title 17]," even when the copies are protected by a U.S. copyright. In short, copies covered by the phrase "lawfully made under [Title 17]" in § 109(a) are not simply those which are lawfully made by the owner of a U.S. copyright. Something more is required. To us, that "something" is the making of the copies within the United States, where the Copyright Act applies. See 2-8 Nimmer [989] on Copyright § 8.12(B)(6)(c), at 8-178.4(6)-(7).

We also read one of the Court's illustrations to be consistent with this understanding. The Court stated that given

a publisher of [a] U.S. edition [of a work] and a publisher of [a] British edition of the same work, each such publisher could make lawful copies. If the author of the work gave the exclusive United States distribution rights—enforceable under the Act—to the publisher of the United States edition and the exclusive British distribution rights to the publisher of the British edition, however, presumably only those made by the publisher of the United States edition would be `lawfully made under this title' within the meaning of § 109(a). The first sale doctrine would not provide the publisher of the British edition who decided to sell in the American market with a defense to an action under § 602(a).

523 U.S. at 148, 118 S.Ct. 1125 (emphasis added and footnote omitted). Assuming the British edition was made outside the United States,^[6] this illustration suggests that "lawfully made under this title" refers exclusively to copies of U.S.-copyrighted works that are made domestically. Were it otherwise, the copies made by the British publisher would also fall within the scope of § 109(a). See 2-8 Nimmer on Copyright § 8.12(B)(6)(c), at 8-178.4(7).

Finally, in the decision's only direct language on the issue, Justice Ginsburg's concurrence cited a copyright treatise for the proposition that "lawfully made under this title" means "lawfully made in the United States." 523 U.S. at 154, 118 S.Ct. 1125 (citing W. Patry, Copyright Law and Practice 166-70 (1997 Supp.)). The majority opinion did not dispute this interpretation, which aligns closely with the one adopted by our circuit. See BMG Music, 952 F.2d at 319.

Costco contends that BMG Music's limitation of § 109(a) to domestically made copies is inconsistent with the plain language of the statute and its legislative history. This criticism has been made before, including by this court. See, e.g., Parfums Givenchy, Inc. v. C & C Beauty Sales, Inc., 832 F.Supp. 1378, 1386-87 (C.D.Cal.1993), aff'd sub nom. Drug Emporium, 38 F.3d at 482 n. 8. Perhaps most compelling is the objection that BMG Music would provide substantially greater copyright protection to foreign-made copies of U.S.-copyrighted works. A U.S. copyright owner, for example, would be unable to exercise distribution rights after one lawful, domestic sale of a watch lawfully made in South Dakota, but, without the limits imposed by § 109(a), the same owner could seemingly exercise distribution rights after even the tenth sale in the United States of a watch lawfully made in Switzerland. The difference would likely encourage U.S. copyright owners to outsource the manufacturing of copies of their work overseas. Drug Emporium and Denbicare, however, resolved this problem by clarifying that parties can raise § 109(a) as a defense in cases involving foreign-made copies so long as a lawful domestic sale has occurred. See Drug Emporium, 38 F.3d at 481; Denbicare, 84 F.3d at 1150. Insofar as Costco contends that § 109(a) should apply to foreign-made copies even in the absence of a lawful domestic sale, the surviving rule from [990] BMG Music requires otherwise. See 952 F.2d at 319.

In summary, our general rule that § 109(a) refers "only to copies legally made ... in the United States," id., is not clearly irreconcilable with Quality King, and, therefore, remains binding precedent. Under this rule, the first sale doctrine is unavailable as a defense to the claims under §§ 106(3) and 602(a) because there is no genuine dispute that Omega manufactured the watches bearing the Omega Globe Design in Switzerland. Id.; Fed. R.Civ.P. 56(c); see also Swatch S.A. v. New City, Inc., 454 F.Supp.2d 1245, 1253-54 (S.D.Fla.2006) (concluding that Quality King is consistent with the interpretation that "lawfully made under this title" means "legally made ... in the United States"); 2 Goldstein on Copyright § 7.6.1, at 143-44 (concluding that Quality King "indicates an intention not to disturb lower court holdings that the first sale defense is unavailable to importers who acquire ownership of gray market goods made abroad").

3.

We need not decide whether Drug Emporium's and Denbicare's exception to the rule in BMG Music also survives Quality King. There is no genuine dispute that the copies of the Omega Globe Design were sold in the United States without Omega's authority. The exception, therefore, does not apply in this case. See Denbicare, 84 F.3d at 1145-46 ("[Section] 109 applies to copies made abroad only if the copies have been sold in the United States by the copyright owner or with its authority."). Because the exception does not apply, the question of its continuing viability cannot affect our conclusion that § 109(a) provides no defense to Omega's claims.

C. Attorney's fees under 17 U.S.C. § 505

The final issue is whether the district court abused its discretion in awarding attorney's fees to Costco. The Copyright Act provides for an "award [of] a reasonable attorney's fee to the prevailing party as part of the costs." 17 U.S.C. § 505. In deciding whether to award fees under this statute, a district court should consider "the degree of success obtained; frivolousness; motivation; objective unreasonableness (both in the factual and legal arguments in the case); and the need in particular circumstances to advance considerations of compensation and deterrence." Columbia Pictures Television, Inc., 259 F.3d at 1197.

The district court's award of $373,003.80 in attorney's fees to Costco was an abuse of discretion because neither party has prevailed in this litigation to this point.

REVERSED AND REMANDED.

[1] "`Gray-market' goods, or `parallel imports,' are genuine products possessing a brand name protected by a trademark or copyright. They are typically manufactured abroad, and purchased and imported into the United States by third parties, thereby bypassing the authorized U.S. distribution channels." Parfums Givenchy, Inc. v. Drug Emporium, Inc., 38 F.3d 477, 481 n. 6 (9th Cir.1994). Retailers are able to sell these products at a discount because the gray market arbitrages international discrepancies in manufacturers' pricing systems.

[2] Section 501(a) provides: "Anyone who violates any of the exclusive rights of the copyright owner as provided by sections 106 through 122, ... or who imports copies . . . into the United States in violation of section 602, is an infringer of the copyright...."

[3] Other parts of § 109 qualify the first sale doctrine of § 109(a), see generally 17 U.S.C. § 109, but the parties do not argue that any of those limiting provisions apply.

[4] Denbicare's rejection of a § 602(a) claim due to the defendant's lack of involvement in importation suggests that Omega's claim under § 602(a) is similarly unmeritorious because, like the defendant in Denbicare, Costco did not import the disputed copies. See 84 F.3d at 1149. However, Costco waived this argument by not raising it in its opening brief. See Greenwood v. FAA, 28 F.3d 971, 977 (9th Cir.1994) ("We review only issues which are argued specifically and distinctly in a party's opening brief."). In any event, we must still decide whether § 109(a) provides a defense against Omega's claim under § 106(3).

[5] "[L]ower courts [are] bound not only by the holdings of higher courts' decisions but also by their `mode of analysis.' " Miller, 335 F.3d at 900 (quoting Antonin Scalia, The Rule of Law as a Law of Rules, 56 U. Chi. L.Rev. 1175, 1177 (1989)).

[6] The illustration offers no specific justification for making this assumption over any other regarding the site of manufacture, but Quality King cannot be "clearly irreconcilable" with our precedent even if the decision merely permits assumptions that are consistent with that precedent. Miller, 335 F.3d at 900.

125 F.3d 580
235 Copr.L.Dec. P 27,686, 44 U.S.P.Q.2d 1153

Annie LEE and Annie Lee & Friends Company, Inc., Plaintiffs-Appellants,
v.
A.R.T. COMPANY, also known as Albuquerque A.R.T. Company,
Defendant-Appellee.

No. 96-2522.
United States Court of Appeals, Seventh Circuit.
Argued Feb. 10, 1997.
Decided Sept. 18, 1997.

[580] P. Scott Neville, Jr., Howse, Howse, Neville & Gray, Geraldine C. Simmons (argued), Salone, Simmons & Murray, Chicago, IL, for Plaintiffs-Appellants.

Joan Pennington, Joseph Krieger, Philip M. Kolehmainen, Mason, Kolehmainen, Rathburn & Wyss, Chicago, IL, George J. Netter (argued), Pasadena, CA, for Defendant-Appellee.

Before BAUER, EASTERBROOK, and DIANE P. WOOD, Circuit Judges.

EASTERBROOK, Circuit Judge.

Annie Lee creates works of art, which she sells through her firm Annie Lee & Friends. Deck the Walls, a chain of outlets for modestly priced art, is among the buyers of her works, which have been registered with the Register of Copyrights. One Deck the Walls store sold some of Lee's notecards and small lithographs to A.R.T. Company, which mounted the works on ceramic tiles (covering the art with transparent epoxy resin in the process) and resold the tiles. Lee contends that these tiles are derivative works, which under 17 U.S.C. § 106(2) may not be prepared without the permission of the copyright proprietor. She seeks both monetary and injunctive relief. Her position has the support of two cases holding that A.R.T.'s business violates the copyright laws. Munoz v. Albuquerque A.R.T. Co., 38 F.3d 1218 (9th Cir. 1994), affirming without published opinion 829 F. Supp. 309 (D. Alaska 1993); Mirage Editions, Inc. v. Albuquerque A.R.T. Co., 856 F.2d 1341 (9th Cir. 1988). Mirage Editions, the only full appellate discussion, dealt with pages cut from books and mounted on tiles; the court of appeals' brief order in Muoz concludes that the reasoning of Mirage Editions is equally applicable to works [581] of art that were sold loose. Our district court disagreed with these decisions and entered summary judgment for the defendant. 925 F. Supp. 576 (N.D. Ill. 1996).

Now one might suppose that this is an open and shut case under the doctrine of first sale, codified at 17 U.S.C. § 109(a). A.R.T. bought the work legitimately, mounted it on a tile, and resold what it had purchased. Because the artist could capture the value of her art's contribution to the finished product as part of the price for the original transaction, the economic rationale for protecting an adaptation as "derivative" is absent. See William M. Landes & Richard A. Posner, An Economic Analysis of Copyright Law, 17 J. Legal Studies 325, 353-57 (1989). An alteration that includes (or consumes) a complete copy of the original lacks economic significance. One work changes hands multiple times, exactly what § 109(a) permits, so it may lack legal significance too. But § 106(2) creates a separate exclusive right, to "prepare derivative works", and Lee believes that affixing the art to the tile is "preparation," so that A.R.T. would have violated § 106(2) even if it had dumped the finished tiles into the Marianas Trench. For the sake of argument we assume that this is so and ask whether card-on-a-tile is a "derivative work" in the first place. 

"Derivative work" is a defined term:

A "derivative work" is a work based upon one or more preexisting works, such as a translation, musical arrangement, dramatization, fictionalization, motion picture version, sound recording, art reproduction, abridgment, condensation, or any other form in which a work may be recast, transformed, or adapted. A work consisting of editorial revisions, annotations, elaborations, or other modifications which, as a whole, represent an original work of authorship, is a "derivative work".

17 U.S.C. § 101. The district court concluded that A.R.T.'s mounting of Lee's works on tile is not an "original work of authorship" because it is no different in form or function from displaying a painting in a frame or placing a medallion in a velvet case. No one believes that a museum violates § 106(2) every time it changes the frame of a painting that is still under copyright, although the choice of frame or glazing affects the impression the art conveys, and many artists specify frames (or pedestals for sculptures) in detail. Munoz and Mirage Editions acknowledge that framing and other traditional means of mounting and displaying art do not infringe authors' exclusive right to make derivative works. Nonetheless, the ninth circuit held, what A.R.T. does creates a derivative work because the epoxy resin bonds the art to the tile. Our district judge thought this a distinction without a difference, and we agree. If changing the way in which a work of art will be displayed creates a derivative work, and if Lee is right about what "prepared" means, then the derivative work is "prepared" when the art is mounted; what happens later is not relevant, because the violation of the § 106(2) right has already occurred. If the framing process does not create a derivative work, then mounting art on a tile, which serves as a flush frame, does not create a derivative work. What is more, the ninth circuit erred in assuming that normal means of mounting and displaying art are easily reversible. A painting is placed in a wooden "stretcher" as part of the framing process; this leads to some punctures (commonly tacks or staples), may entail trimming the edges of the canvas, and may affect the surface of the painting as well. Works by Jackson Pollock are notoriously hard to mount without damage, given the thickness of their paint. As a prelude to framing, photographs, prints, and posters may be mounted on stiff boards using wax sheets, but sometimes glue or another more durable substance is employed to create the bond.

Lee wages a vigorous attack on the district court's conclusion that A.R.T.'s mounting process cannot create a derivative work because the change to the work "as a whole" is not sufficiently original to support a copyright. Cases such as Gracen v. The Bradford Exchange, Inc., 698 F.2d 300 (7th Cir. 1983), show that neither A.R.T. nor Lee herself could have obtained a copyright in the card-on-a-tile, thereby not only extending the period of protection for the images but also eliminating competition in one medium of display. After the ninth circuit held that its [582] mounting process created derivative works, A.R.T. tried to obtain a copyright in one of its products; the Register of Copyrights sensibly informed A.R.T. that the card-on-a-tile could not be copyrighted independently of the note card itself. But Lee says that this is irrelevant--that a change in a work's appearance may infringe the exclusive right under § 106(2) even if the alteration is too trivial to support an independent copyright. Pointing to the word "original" in the second sentence of the statutory definition, the district judge held that "originality" is essential to a derivative work. This understanding has the support of both cases and respected commentators. E.g., L. Batlin & Son, Inc. v. Snyder, 536 F.2d 486 (2d Cir. 1976); Melville B. Nimmer & David Nimmer, 1 Nimmer on Copyrights § 3.03 (1997). Pointing to the fact that the first sentence in the statutory definition omits any reference to originality, Lee insists that a work may be derivative despite the mechanical nature of the transformation. This view, too, has the support of both cases and respected commentators. E.g., Lone Ranger Television, Inc. v. Program Radio Corp., 740 F.2d 718, 722 (9th Cir. 1984); Paul Goldstein, Copyright: Principles, Law and Practice § 5.3.1 (2d ed. 1996) (suggesting that a transformation is covered by § 106(2) whenever it creates a "new work for a different market").

Fortunately, it is not necessary for us to choose sides. Assume for the moment that the first sentence recognizes a set of non-original derivative works. To prevail, then, Lee must show that A.R.T. altered her works in one of the ways mentioned in the first sentence. The tile is not an "art reproduction"; A.R.T. purchased and mounted Lee's original works. That leaves the residual clause: "any other form in which a work may be recast, transformed, or adapted." None of these words fits what A.R.T. did. Lee's works were not "recast" or "adapted". "Transformed" comes closer and gives the ninth circuit some purchase for its view that the permanence of the bond between art and base matters. Yet the copyrighted note cards and lithographs were not "transformed" in the slightest. The art was bonded to a slab of ceramic, but it was not changed in the process. It still depicts exactly what it depicted when it left Lee's studio. See William F. Patry, Copyright Law and Practice 823-24 (1994) (disapproving Mirage Editions on this ground).^[1] If mounting works a "transformation," then changing a painting's frame or a photograph's mat equally produces a derivative work. Indeed, if Lee is right about the meaning of the definition's first sentence, then any alteration of a work, however slight, requires the author's permission. We asked at oral argument what would happen if a purchaser jotted a note on one of the note cards, or used it as a coaster for a drink, or cut it in half, or if a collector applied his seal (as is common in Japan); Lee's counsel replied that such changes prepare derivative works, but that as a practical matter artists would not file suit. A definition of derivative work that makes criminals out of art collectors and tourists is jarring despite Lee's gracious offer not to commence civil litigation.

If Lee (and the ninth circuit) are right about what counts as a derivative work, then the United States has established through the back door an extraordinarily broad version of authors' moral rights, under which artists may block any modification of their works of which they disapprove. No European version of droit moral goes this far. Until recently it was accepted wisdom that the United States did not enforce any claim of moral rights; even bowdlerization of a work was permitted unless the modifications produced a new work so different that it infringed the exclusive right under § 106(2). Compare WGN Continental Broadcasting Co. v. United Video, Inc., 693 F.2d 622 (7th Cir. 1982), with Gilliam v. American Broadcasting Companies, Inc., 538 F.2d 14, 24 (2d Cir. 1976). The Visual Artists Rights Act of 1990, Pub. L. 101-650, 104 Stat. 5089, 5123-33, moves federal law in the direction of moral rights, but the cornerstone of the new statute, 17 U.S.C. § 106A, does not assist [583] Lee. Section 106A(a)(3)(A) gives an artist the right to "prevent any intentional distortion, mutilation, or other modification of that work which would be prejudicial to his or her honor or reputation". At oral argument Lee's lawyer disclaimed any contention that the sale of her works on tile has damaged her honor or reputation. What is more, § 106A applies only to a "work of visual art", a new term defined in § 101 to mean either a unique work or part of a limited edition (200 copies or fewer) that has been "signed and consecutively numbered by the author". Lee's note cards and lithographs are not works of visual art under this definition, so she could not invoke § 106A even if A.R.T.'s use of her works to produce kitsch had damaged her reputation. It would not be sound to use § 106(2) to provide artists with exclusive rights deliberately omitted from the Visual Artists Rights Act. We therefore decline to follow Munoz and Mirage Editions.[2]

AFFIRMED.

[1] Scholarly disapproval of Mirage Editions has been widespread. Goldstein § 5.3 at 5:81-82; Nimmer & Nimmer § 3.03; Wendy J. Gordon, On Owning Information: Intellectual Property and the Restitutionary Impulse, 78 Va. L. Rev. 149, 255 n. 401 (1992).

[2] Because this opinion creates a conflict among the circuits, it has been circulated to all judges in active service. See Circuit Rule 40(e). No judge requested a hearing en banc.

856 F.2d 1341 (1988)

No. 87-6465.

Argued and Submitted April 8, 1988.

Decided September 7, 1988.

[1342] George J. Netter, Pasadena, Cal., for defendant-appellant.

Gary S. Phillips, Rosenberg, Nagler & Phillips, Beverly Hills, Cal., for plaintiffs-appellees.

Before BRUNETTI, KOZINSKI and THOMPSON, Circuit Judges.

BRUNETTI, Circuit Judge:

Albuquerque A.R.T. (appellant or A.R.T.) appeals the district court's granting of summary judgment in favor of appellees Mirage, Dumas, and Van Der Marck (Mirage). The district court, in granting summary judgment, found that appellant had infringed Mirage's copyright and issued an order enjoining-appellant from further infringing Mirage's copyright.

Patrick Nagel was an artist whose works appeared in many media including lithographs, posters, serigraphs, and as graphic art in many magazines, most notably Playboy. Nagel died in 1984. His widow Jennifer Dumas owns the copyrights to the Nagel art works which Nagel owned at the time of his death. Mirage is the exclusive publisher of Nagel's works and also owns the copyrights to many of those works. Dumas and Mirage own all of the copyrights to Nagel's works. No one else holds a copyright in any Nagel work. Appellee Alfred Van Der Marck Editions, Inc. is the licensee of Dumas and Mirage and the publisher of the commemorative book entitled NAGEL: The Art of Patrick Nagel ("the book"), which is a compilation of selected copyrighted individual art works and personal commentaries.

Since 1984, the primary business of appellant has consisted of: 1) purchasing artwork prints or books including good quality artwork page prints therein; 2) gluing each individual print or page print onto a rectangular sheet of black plastic material exposing a narrow black margin around the print; 3) gluing the black sheet with print onto a major surface of a rectangular white ceramic tile; 4) applying a transparent plastic film over the print, black sheet and ceramic tile surface; and 5) offering the tile with artwork mounted thereon for sale in the retail market.

It is undisputed, in this action, that appellant did the above process with the Nagel book. The appellant removed selected pages from the book, mounted them individually onto ceramic tiles and sold the tiles at retail.

Mirage, Dumas and Van Der Marck brought an action alleging infringement of registered copyrights in the artwork of Nagel and in the book. Mirage also alleged trademark infringement and unfair competition under the Lanham Act, 15 U.S.C. [1343] § 1051 et seq. and the state law of unfair competition, Cal.Bus. & Prof.Code §§ 17200 et seq.

Appellant moved for summary judgment on the Lanham Act and Copyright Act causes of action. The district court granted summary judgment as to the Lanham Act cause of action but denied summary judgment on the copyright cause of action. Mirage then moved for summary judgment on the copyright claim which was granted. The court also enjoined appellants from removing individual art images from the book, mounting each individual image onto a separate tile and advertising for sale and/or selling the tiles with the images mounted thereon.

The Copyright Act of 1976, 17 U.S.C. § 101 et seq., confers upon the copyright holder exclusive rights to make several uses of his copyright. Among those rights are: (1) the right to reproduce the copyrighted work in copies, 17 U.S.C. § 106(1); (2) the right to prepare derivative works based upon the copyrighted work, 17 U.S.C. § 106(2); (3) the right to distribute copies of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease or lending, 17 U.S.C. § 106(3); and (4) in the case of literary, pictorial, graphic and sculptural works, including individual images, the right to display the copyrighted work publicly.

The district court concluded appellant infringed the copyrights in the individual images through its tile-preparing process and also concluded that the resulting products comprised derivative works.

Appellant contends that there has been no copyright infringement because (1) its tiles are not derivative works, and (2) the "first sale" doctrine precludes a finding of infringement.

The Copyright Act of 1976, 17 U.S.C. § 101 defines a derivative work as:

[A] work based upon one or more preexisting works such as a translation, musical arrangement, dramatization, fictionalization, motion picture version, sound recording, art reproduction, abridgment, condensation or any other form in which a work may be recast, transformed, or adapted. A work consisting of editorial revisions, annotations, elaborations, or other modifications which, as a whole, represent an original work of authorship is a "derivative work."

(Emphasis added).

The protection of derivative rights extends beyond mere protection against unauthorized copying to include the right to make other versions of, perform, or exhibit the work. Lone Ranger Television v. Program Radio Corp., 740 F.2d 718, 722 (9th Cir.1984); Russell v. Price, 612 F.2d 1123, 1128 n. 16 (9th Cir.1979).

Melvin Nimmer in his treatise on copyright law wrote:

[A] work will be considered a derivative work only if it would be considered an infringing work if the material which it has derived from a preexisting work had been taken without the consent of a copyright proprietor of such preexisting work.

1 Nimmer on Copyright § 3.01 (1986) cited in Litchfield v. Spielberg, 736 F.2d 1352, 1357 (9th Cir.1984), cert. denied, 470 U.S. 1052, 105 S.Ct. 1753, 84 L.Ed.2d 817 (1985); United States v. Taxe, 540 F.2d 961, 965 n. 2 (9th Cir.1976), cert. denied, 429 U.S. 1040, 97 S.Ct. 737, 50 L.Ed.2d 751 (1977).

What appellant has clearly done here is to make another version of Nagel's art works, Lone Ranger, supra, and that amounts to preparation of a derivative work. By borrowing and mounting the preexisting, copyrighted individual art images without the consent of the copyright proprietors — Mirage and Dumas as to the art works and Van Der Marck as to the book — appellant has prepared a derivative work and infringed the subject copyrights. Nimmer, supra.

Appellant's contention that since it has not engaged in "art reproduction" and therefore its tiles are not derivative works is not fully dispositive of this issue. Appellant has ignored the disjunctive phrase "or any other form in which a work may be recast, transformed or adapted." The legislative history of the Copyright Act of 1976 indicates that Congress intended that [1344] for a violation of the right to prepare derivative works to occur "the infringing work must incorporate a portion of the copyrighted work in some form." 1976 U.S.Code Cong. & Admin.News 5659, 5675. (emphasis added). The language "recast, transformed or adapted" seems to encompass other alternatives besides simple art reproduction. By removing the individual images from the book and placing them on the tiles, perhaps the appellant has not accomplished reproduction. We conclude, though, that appellant has certainly recast or transformed the individual images by incorporating them into its tile-preparing process.

The "first sale" doctrine, which appellant also relies on in its contention that no copyright infringement has occurred, appears at 17 U.S.C. § 109(a). That section provides:

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.

In United States v. Wise, 550 F.2d 1180 (9th Cir.1977), which concerned a criminal prosecution under the pre-1976 Copyright Act, this court held that:

[T]he "first sale" doctrine provides that where a copyright owner parts with title to a particular copy of his copyrighted work, he divests himself of his exclusive right to vend that particular copy. While the proprietor's other copyright rights (reprinting, copying, etc.) remain unimpaired, the exclusive right to vend the transferred copy rests with the vendee, who is not restricted by statute from further transfers of that copy.

550 F.2d at 1187.

We recognize that, under the "first sale" doctrine as enunciated at 17 U.S.C. § 109(a) and as discussed in Wise, appellant can purchase a copy of the Nagel book and subsequently alienate its ownership in that book. However, the right to transfer applies only to the particular copy of the book which appellant has purchased and nothing else. The mere sale of the book to the appellant without a specific transfer by the copyright holder of its exclusive right to prepare derivative works, does not transfer that right to appellant. The derivative works right, remains unimpaired and with the copyright proprietors — Mirage, Dumas and Van Der Marck. As we have previously concluded that appellant's tile-preparing process results in derivative works and as the exclusive right to prepare derivative works belongs to the copyright holder, the "first sale" doctrine does not bar the appellees' copyright infringement claims.

We AFFIRM.