Nail in the coffin for covenants not to sue? An analysis of FCJ judgment, X ZR 123/20, "CQI report II"

In a recent decision (docket no. X ZR 123/20), the German Federal Court of Justice (FCJ) commented extensively on the important question of the exhaustion effect of a "covenant not to sue". In its decision, the FCJ treats both a "covenant not to sue" and a "covenant to be sued last" as a license, with the consequence that the contracting party, i.e., patent proprietor, is treated in the same way as a “normal” licensor and can no longer assert such patent rights against third parties.

Facts of the case

The owner of a mobile communications patent filed a complaint against the distributor of mobile communications devices for patent infringement based on an LTE standard-essential patent. The patent proprietor had previously concluded agreements with the manufacturers of the chipsets used in the accused embodiments. These agreements included provisions according to which the chip manufacturers may only be sued for patent infringement once all eligible third parties had been sued by the patent proprietor first ("covenant to be sued last"). The defendant and distributor of the accused embodiments claimed that it had marketed the products on the basis of the "covenant to be sued last" with the consent of the patent owner, which is why exhaustion had occurred. The FCJ agreed.

Grounds of the decision

The FCJ starts by confirming that the exclusive right from a product patent is exhausted with respect to such products that have been put on the market by the patent proprietor or with its consent by a third party. In the case of products that are put on the market by third parties however, according to the FCJ, the exhaustion does not necessarily require that an effective license has been granted to the third party. In the opinion of the FCJ, an item that makes use of the patent is also put on the market with the consent of the patent proprietor in the case of a "covenant not to sue", i.e. an obligation on the part of the patent proprietor not to assert claims against the contracting party for patent infringement. The FCJ reasons that such an obligation by the patent proprietor expresses that it will not assert any rights from the patent against its contracting party in a manner sufficient for exhaustion of its rights.

According to the FCJ, the same applies in principle to a "covenant to be sued last". A limitation agreed in the agreement to assert claims against the contracting party's customers for infringement of the patent is generally without effect in relation to third parties. The consequence of exhaustion is that the patentee loses its ability to determine the further fate of the protected subject matter as conveyed by the patent. This mandatory legal consequence cannot be excluded by contract with effect for third parties. According to the FCJ this may only be different in singular cases if the patent proprietor merely quietly accepts and does not challenge the infringing acts instead of clearly waiving its right to sue for infringement. In the case of a "covenant not to sue", in which the patent proprietor undertakes not to raise any objections based on the patent against the putting on the market of products by its contractual partner, this is typically not the case. A reservation of rights vis-à-vis third parties would then merely represent an ineffective attempt to limit the scope of exhaustion.

In connection with the exhaustion effect of a covenant, the FCJ emphasizes that this only applies to products that were put on the market with the approval of the patent proprietor. Further, the FCJ makes clear that consent to the manufacture of products (i.e., chips in the case at hand) can be seen as implicit consent to the sale of mobile devices equipped with them, and consequently the exhaustion effect extending to them. Such an extension is generally to be inferred if the consent of the patent proprietor relates to the putting on the market of the complete device.

Practical advice

The decision has considerable practical relevance, as "covenant not to sue" and in particular "covenant to be sued last" clauses are negotiated by patent proprietors precisely with the goal of limiting the exhaustion effect to the specific manufactured component in order to keep the options open for downstream licenses in the supply chain.

With this decision of the FCJ, this practice no longer serves that purpose. Whether exhaustion of rights occurs in case a “covenant” is agreed, largely depends on how easy and likely it is that the manufacturer has to expect to be sued for patent infringement by the patent proprietor. This can presumably only be assumed if the patent proprietor expressly reserves the right to assert claims for injunctive relief against the contracting party, effectively voiding the “covenant”.