More Impressions About Patent Exhaustion

[This post was co-authored with Lisa Larrimore Ouellette and cross-posted at Written Description.]

As we explained last week, the full impact of the Supreme Court’s decision in Impression Products v. Lexmark will depend on whether courts are willing to view creative patent transactions as licenses (which do not exhaust the patentee’s rights) rather than sales (which, after Impression, now do). While it is too early to answer that question, we can already anticipate answers to two related questions regarding Impression’s impact: (1) What does the decision mean for pharmaceutical prices in the United States and abroad?; and (2) How will Impression affect information costs in markets for patented products? With respect to the first question, we expect that Impression will put upward pressure on pharmaceutical prices in developing countries — and downward pressure on prices in the United States — notwithstanding the fact that the importation of drugs from abroad will remain illegal under most circumstances. As for the second question, we are skeptical that Impression will have a substantial effect on information costs in markets for patented products, notwithstanding some of the enthusiastic commentary in the technology press immediately after the decision.

Below, we explain both of these conclusions in more detail.

1. What does Impression mean for pharmaceutical prices in the United States and abroad?

We’ve written before that a decision in favor of the petitioners in Impression would raise the price of patented products in less developed countries. We’ve emphasized that the decision will potentially affect not just for pharmaceutical prices, but also prices for products like the low-cost XO tablet. We have yet to encounter any real rebuttal to our claim that a ruling for Impression will lead to higher prices of non-pharmaceutical patented products in less developed countries. The effect of the Impression decision on pharmaceutical prices is somewhat less clear.

As Erika Lietzan explains in an excellent overview of the U.S. drug importation regime, it is illegal to import pharmaceutical products from abroad under most (though not all) circumstances. Even so, the illegality of importation doesn’t mean there are no imports. Americans spent over $1 billion on Canadian drug imports in 2003, and the number is surely higher today with over 3,400 online pharmacies like canadadrugs.com. Brand-name companies have used patent litigation to stem this flow; now they must rely on discretionary government enforcement. And patent issues have long been viewed as a hurdle to proposals to legalize drug importation, which may now gain more traction.

2. But isn’t there at least going to be a substantial benefit in terms of reduced information costs regarding patent rights?

Perhaps. The Supreme Court said that “[t]he inconvenience and annoyance to the public that [post-sale restrictions] would occasion are too obvious to require illustration,” and then illustrated the point anyway with a hypothetical car repair shop for which the “smooth flow of commerce would sputter if companies that make the thousands of parts that go into a vehicle could keep their patent rights after the first sale,” leading to the “threat of patent liability.”

While compelling prose, this glib discussion fails to recognize the complexity of the issue, including the lack of evidence to support this “obvious” conclusion. Under the Court’s logic, the flow of commerce should have long since sputtered: post-sale restrictions have been clearly permissible for at least the past twenty-five years. And while Impression certainly eliminates some information costs, repair shops must still bear many information costs to ensure their activities are noninfringing, such as checking for patent rights owned by parties who did not authorize the initial sale. This concern is far from hypothetical; indeed, an earlier Supreme Court case found liability for repairing an infringing convertible top. But it is more difficult to credibly claim that this problem has “clog[ged] the channels of commerce,” given the lack of concrete examples of significant information-cost externalities in the amicus briefs and at oral argument.

Of course, the more willing courts are to recognize transactions as licenses rather than sales, the greater the information costs will be on downstream users of patented technologies — undermining this benefit of the Court’s decision, but also mitigating the harms of broader patent exhaustion. As Guy Rub concisely put it, the court has merely kicked the can down the road, delaying the choice between the tradeoffs that patent exhaustion inevitably presents.