Japanese Patent Licensing: What Happens to a Licensee's Rights if They Breach Territorial Restrictions or Fail to Disclose Improvements?

Patent license agreements are complex instruments that define the rights and obligations of both the patentee (licensor) and the licensee. When a licensee steps outside the agreed-upon terms, a host of legal questions can arise. Beyond simple breach of contract, certain actions by a licensee, particularly concerning the sale of patented products, can intersect with the Japanese doctrine of patent exhaustion. This doctrine generally dictates that once a patented product is lawfully sold, the patentee loses certain rights to control that specific item. But what happens when the "lawfulness" of that first sale is tainted by a licensee's breach?

This article explores how Japanese patent law addresses situations where a licensee breaches specific terms of their license—such as territorial restrictions or obligations to disclose technical improvements—and the resulting impact on the patent exhaustion principle and the rights of downstream purchasers.

Patent Exhaustion in Japan: A Quick Refresher

Under Japanese patent law, the doctrine of patent exhaustion (shōjin) holds that when a patented product is placed on the market in Japan by the patentee or with their valid consent (e.g., by an authorized licensee), the patent rights with respect to that specific, sold unit are generally considered "exhausted." This means the patentee can no longer assert their patent rights to control the subsequent use or resale of that particular unit by downstream purchasers. The primary rationales are to ensure the free circulation of goods once legitimately introduced into commerce and to prevent the patentee from "double-dipping" by extracting further royalties from the same item.

Interestingly, this principle can also extend to products sold by an applicant before a patent is even granted. If the entity that applied for the patent (and later becomes the patentee) sells products embodying the invention while the application is pending, there's a strong argument, supported by some Japanese court dicta (e.g., Osaka District Court, July 20, 2006), that exhaustion should still apply to those pre-grant sold units once the patent issues. The reasoning is that the applicant benefits from these early sales, and the smooth circulation of these goods should be similarly protected.

Breach of Territorial Restrictions and Its Impact on Exhaustion

Patent licenses often include territorial restrictions, limiting where a licensee can manufacture or sell the patented product (e.g., "Kanto region only").

Scenario 1: Licensee Sells Within the Licensed Territory; Product Subsequently Moves Outside

Suppose a licensee manufactures and sells a patented product strictly within their licensed territory in Japan (e.g., the Kanto region). A customer lawfully purchases this product within Kanto and then independently takes it to or resells it in another region of Japan (e.g., Kansai) where the original licensee was not authorized to sell. Are the patent rights exhausted nationwide for this specific unit?

The prevailing view in Japan for domestic territorial restrictions is that once a product is lawfully sold by an authorized licensee within their designated Japanese territory, the patentee's rights are exhausted with respect to that unit throughout Japan. Restricting exhaustion to only the licensed territory would unduly impede the free domestic circulation of goods. Patentees can, and often do, factor in the potential for nationwide distribution when negotiating license terms and royalties for territorially limited licenses within Japan. Thus, the customer using or reselling the product in Kansai would likely not be infringing.

Scenario 2: Licensee Sells Outside the Licensed Territory (Direct Breach)

Now consider a different situation: the licensee, authorized to sell only in Kanto, directly sells the patented product in Kansai. This act is a clear breach of the license agreement and, more importantly, likely constitutes direct patent infringement by the licensee because they are operating outside the scope of their granted license.

Products sold by a licensee through such an unauthorized, infringing act are not considered to have been "lawfully" placed on the market with the patentee's consent. Consequently, the doctrine of patent exhaustion does not apply to these specific units. The patentee retains the right to sue:

• The licensee for direct patent infringement for sales made outside the licensed territory.
• Downstream purchasers/users of these unauthorized products for patent infringement (e.g., for using or reselling the product in Kansai or elsewhere in Japan).

For downstream purchasers, their liability would depend on the usual rules of patent infringement. While Japanese Patent Act Article 103 presumes negligence on the part of an infringer, an innocent downstream purchaser who was unaware of the licensee's territorial breach might try to rebut this presumption, though this can be challenging for commercial entities.

Breach of Other License Clauses: The Duty to Report Technical Improvements

What if the licensee breaches a clause that doesn't directly govern where or how many products can be sold, but rather an ancillary obligation, such as a duty to report technical improvements they make to the patented invention?

Scenario: Failure to Report Improvements

A license agreement requires the licensee to promptly inform the licensor of any technical improvements made to the licensed product. The licensee develops an improvement, incorporates it into the products they sell (which still fall under the claims of the original patent and are sold within the licensed territory and quantity limits), but fails to report this improvement to the licensor. Does this contractual breach mean that the sold products are now "unauthorized," thereby preventing patent exhaustion?

The key question is whether the breached clause is so fundamental to the grant of the patent license that its violation renders the licensee's acts of making and selling the product acts of patent infringement.

• Distinguishing Core Scope from Ancillary Obligations: Terms that define the core scope of the license—such as the specific patented technology licensed, the territory of sale, the duration of the license, the field of use, or quantity restrictions—are often seen as conditions of the license itself. Operating outside these parameters typically means the licensee is acting without a license and is therefore directly infringing the patent. Products sold through such infringing acts do not benefit from exhaustion.
• Nature of the "Duty to Report Improvements" Clause: A clause requiring the reporting of improvements, while contractually important, does not inherently define the scope of permitted exploitation of the original patent in the same way a territorial restriction does. The licensee might still be making and selling a product that is covered by the patent and within the agreed territory, quantity, and field of use. The failure to report the improvement is a breach of a contractual covenant, giving the licensor contractual remedies (e.g., damages for the breach, potentially termination of the license if the breach is material).
• Impact on Exhaustion: The argument, as suggested by some Japanese legal commentary, is that if the licensee's act of selling the product itself (albeit an improved one that still infringes the original patent) was otherwise within the authorized bounds of the license (e.g., correct product type, territory, quantity), the mere failure to report an improvement does not retroactively strip the authorization for those sales. If the sales themselves were not acts of patent infringement by the licensee, then the patent rights for those specific units would be exhausted. The licensor's remedy for the failure to report lies primarily in contract law, not necessarily in treating every subsequently sold unit as an infringing item immune from exhaustion.

The crucial distinction lies in whether the breach transforms the licensee's otherwise licensed activity into an act of patent infringement. A failure to pay royalties as per an agreed schedule, for example, is a contractual breach but doesn't automatically make the licensee an infringer of the patent for products already sold (though it might be grounds to terminate the license for future activity). Similarly, a failure to report an improvement, while a breach, might not convert an otherwise authorized sale into an infringing one if the product sold still embodies the licensed patent and is within other key scope limitations.

Patent Infringement vs. Breach of Contract: A Necessary Distinction

It is vital to distinguish between actions by a licensee that constitute patent infringement and those that are "merely" a breach of contractual obligations.

• Patent Infringement by Licensee: Typically occurs when the licensee acts outside the scope of the rights granted by the license. Examples include selling in an unlicensed territory, selling products for an unlicensed field of use, selling after the license has terminated, or exceeding licensed production/sale quantities. In these cases, the licensee is acting as if they have no license for those specific acts.
• Breach of Contract Only: Occurs when the licensee acts within the scope of the licensed patent rights but fails to fulfill other contractual promises, such as payment terms, reporting obligations, quality control standards (unless tied to the definition of the licensed product), or maintaining confidentiality of certain information.

When the licensee's act is patent infringement, products sold through that act are infringing, and no exhaustion occurs. Downstream users can also be liable. When the licensee's act is "only" a breach of contract but the sale itself was within the license's scope, then exhaustion typically applies to those products, and the licensor's remedies are primarily contractual against the licensee.

Conclusion: Clarity is Key

The interaction between licensee conduct and the doctrine of patent exhaustion in Japan underscores the importance of clearly drafted license agreements.

• When a licensee sells products in direct violation of the scope of their license (e.g., outside a licensed territory), those specific products are generally not subject to patent exhaustion, and both the licensee and potentially downstream purchasers can face infringement liability.
• However, if a licensee breaches more ancillary contractual terms, such as a duty to report technical improvements, but the products sold still fall within the licensed patent and the primary scope limitations (territory, quantity, field of use), the argument that patent rights for those units are exhausted is stronger. The licensor's primary recourse for such breaches would be contractual.

For businesses, this highlights the need to carefully define the scope of licensed rights and to distinguish between conditions that limit this scope (breach of which is patent infringement) and other contractual covenants. This clarity is essential for predicting the enforceability of patent rights against both disobedient licensees and third parties further down the distribution chain.