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PATENTS
The
author argues that the Federal Circuit's analytical method for determining
patent infringement damages can provide patentees “windfall
recoveries” that Congress sought to eliminate almost 70 years
ago.
BNA Insights
Infringer's Profits Redux: The Analytical Method
of Determining Patent Infringement Reasonable Royalty Damages
Mr.
Rooklidge, a partner at Jones Day in Irvine, Calif., practices intellectual
property litigation and related counseling, focusing on patent infringement
trial and appellate litigation. He thanks Hon. Martha Gooding, Blake
Inglish and Mary Woodford for their helpful criticisms and suggestions
on drafts of this article. The views expressed in this paper should
not be attributed to those reviewers, Jones Day, any of its lawyers
or clients, or anyone else.
1 Albert S. Davis Jr., Royalty—Rate
and Basis, in The Encyclopedia
of Patent Practice
and Invention Management 703,
705 (R. Calvert ed., 1964).
The
Federal Circuit recently characterized the award of infringer's profits
to a patentee as an “antiquated damages regime.”
2
Indeed, almost 70 years ago, Congress
eliminated the infringer's profits as a remedy for utility patent
infringement, leaving the patentee with damages sufficient to compensate
for “use made of the invention by the infringer.” The
principal reasons for making this change were the difficulty in apportioning
between the profits properly awardable to the patentee for the infringer's
use of the invention and the profits attributable to the infringer's
contributions,
3
and to avoid patentees
obtaining windfall recoveries where apportionment could not be performed.
4
2 Univ.
of Pittsburgh v. Varian Med. Sys., Inc., 561 F. App'x 934 (Fed. Cir.
2014) (71 PTD, 4/14/14).
3 See H.R. Rep. No. 1587, 79th Cong.,
2d Sess. 2 (1946), reprinted in U.S.C.C.S. 79th Cong.,
2d Sess. 1386-87 (1946); see also Kori Corp.
v. Wilco Marsh Buggies & Draglines, Inc., 761 F.2d 649, 654-55, 225 U.S.P.Q. 985 (Fed.
Cir. 1985).
4 SeeRecovery
in Patent Infringement Suits, H.R. 5231, 79th Cong., 2d Sess.
3, 14-15 (1946) (statement of Hon. Robert K. Henry of Wisconsin decrying
that patentees obtain “in very many cases enormously more than
that to which he is really entitled”).
At
the same time it eliminated the remedy of infringer's profits, Congress
placed a floor on the patentee's damages of “no less than a
reasonable royalty.”
5
Now, almost 70 years later, although the
predominant patent damages reasonable royalty analysis is the hypothetical
negotiation, damages experts in patent infringement cases are advocating
basing reasonable royalty awards on the “residual” or
other portion of the accused infringer's profit (anticipated or actual)
under the so-called “analytical method.” What is more,
courts, including the Federal Circuit, have allowed such testimony
without any analysis of the hypothetical negotiation.
This
paper reviews the historical development of and the current case law
on the use of infringer's profits in reasonable royalty analyses and
concludes that the analytical method, as articulated by the Federal
Circuit, was developed in error, is an arbitrary rule of thumb that
in most circumstances bears no relation to the value of the patentee's
loss from the infringing use, and in some circumstances has turned
into a mere proxy for the infringer's apportioned profits, which Congress
long ago rejected as a utility patent infringement remedy. As a result, “analytical
method” damages testimony not only can provide patentees with
the very “windfall recoveries” Congress sought to avoid
in eliminating the infringer's profit as a utility patent infringement
remedy, but also can result in compensating patentees for far more
than “the use made of the invention.”
6
6 Id.
A recent study concluded that “[d]amages awards for [non-practicing
entities] averaged more than triple those for practicing entities
over the last four years” at least in part because non-practicing
entities “are ineligible for lost profit damages,” which “can
be more difficult to establish.” PriceWaterhouseCoopers, 2014
Patent Litigation Study 2-3, 9 (2014). Professor Lemley argues
that the situation in which “the reasonable royalty approach
systematically overcompensates patent owners in component industries …
has gotten so bad that some patentees who can prove lost profits elect
instead to seek a ‘reasonable’ royalty that is far in
excess of both what the parties would have negotiated and of the actual
losses the patentee suffered.” Mark A. Lemley, Distinguishing
Lost Profits From Reasonable Royalties, 51 Wm. & Mary L.
Rev. 655, 6687 (2009).
The Relevance of Infringer's Profits to Reasonable
Royalty Patent Damages
Identifying
the relevance of infringer's profits to the reasonable royalty remedy
requires a brief review of the development of patent infringement
damages remedies. In the Patent Act of 1790, Congress provided for
an award of damages in an action at law, and in the Patent Act of
1836 Congress added the remedy of an award of the infringer's profits
in an action in equity.
7
In practice, however,
the latter remedy was difficult to prove,
8
so in 1870 Congress
authorized the court in equity to award both the infringer's profits
and compensatory damages,
9
which
the courts construed as authorizing an award of damages only insofar
as “the injury sustained by the infringement is plainly greater
than the aggregate of what was made by the [infringer.]”
10
7 See generallyNike,
Inc. v. Wal-Mart Stores, Inc., 138 F.3d 1437, 1440, 46 U.S.P.Q.2d 1001 (Fed.
Cir. 1998).
9 Act of 1870, 16
Stat. 201.
10 Birdsall, 93 U.S. at
69.
Because
courts limited patentees to that portion of the infringer's profits
which the patentee could prove attributable to the patented feature,
11
through a process known as “apportionment,”
12
patentees continued to face difficulty
in proving the amount of the infringers' profits, and they often found
themselves relegated to an award of nominal damages. To ameliorate
the harsh effect on patentees who could not prove either an established
royalty rate or lost profits, the courts developed the reasonable
royalty analysis, which the Supreme Court first sanctioned by that
name in 1915
13
and
which Congress then grafted onto the patent damages statute in 1922.
14
12 Apportionment is said to be “a rational
separation of the net profits so that neither party may have what
rightfully belongs to the other….” Dowagiac
Mfg. Co. v. Minnesota Moline Plow Co., 235 U.S. 641, 647 (1915).
13 Dowagiac, 235 U.S. at
648 (holding that, where no established royalty could be proven, the
patentee may “show the value [of what was taken] by proving
what would have been a reasonable royalty, considering the nature
of the invention, its utility and advantages, and the extent of the
use involved.”). By the time the Dowagiac Court
sanctioned the reasonable royalty approach, the circuit courts had
been applying that approach for decades. Id. at 649-50.
Perhaps the most comprehensive analysis of the pre-Dowagiac opinions
may be found in U.S. Frumentum Co. v. Lauhoff, 216 F. 610, 615-26 (6th Cir. 1914),
which traces the development of the reasonable royalty to Suffolk
v. Hayden, 70 U.S. 315,
319-20 (1865) (“There being no established patent or license
fee in the case, in order to get at a fair measure of damages, or
even an approximation to it, general evidence must necessarily be
resorted to. And what evidence could be more appropriate and pertinent
than that of the utility of the invention over the old modes or devices
that had been used for working out similar results? With a knowledge
of these benefits to the persons who have used the invention, and
the extent of the use by the infringer, a jury will be in possession
of material and controlling facts that may enable them, in the exercise
of sound judgment, to ascertain the damages, or, in other words, the
loss to the patentee or owner, by the piracy, instead of purchase
of the use of the invention.”).
14 Act of February 18, 1922, Ch. 58, 42 Stat. 392. Although the courts
previously had referred to “reasonable royalty,” the 1922
Act used the formulation “reasonable sum as profits or general
damages.” Not until the 1946 Act did Congress adopt the phrase “not
less than a reasonable royalty.” Act of August 1, 1946, Ch.
726, §1, 60 Stat. 778.
In
1946, Congress both required that the patentee recover at least a
reasonable royalty and eliminated from the patent damages statute
reference to the award of infringer's profits.
15
Because neither the language nor the legislative
history of the subsequent “codification” of the patent
statute in 1952 reflected the continued availability of infringer's
damages, the circuits and district courts subsequently expressed confusion
over whether they could continue to award a patentee damages in the
amount of the infringer's profits, with some continuing to do so despite
Congress's apparent elimination of that remedy from the statute.
16
The Supreme Court eliminated that confusion
in its 1964 opinion in Aro Manufacturing Co. v. Convertible
Top Replacement Co. by holding that under the 1952 Act
the patentee could not recover the infringer's profits “as such.”
17
15 Act of August 1, 1946, Ch. 726, §1, 60 Stat. 778. The legislative history
of the 1946 Act, the Federal Circuit has asserted, explains that the
new statute “would not preclude the recovery of profits as an
element of general damages.” Kori v. Wilco,
761 F.2d at 654 (quoting H.R. Rep. No. 1587, 79th Cong., 2d Sess.
(1946); S. Rep. No. 1503, 79th Cong., 2d Sess. (1946)).
16 See, e.g., William
Bros Boiler & Mfg. Co. v. Gibson Stewart Co., 312 F.2d 385, 386, 136 U.S.P.Q. 239 (6th
Cir. 1963) (concurring in the special master's ruling that infringer “has
shown no good reason, and has furnished the Master with no satisfactory
accounting figures why the [infringer's] gross profits should not
be taken into consideration as a measure of damages, in the absence
of any other suitable measure.”); Graham v. Jeoffroy
Mfg., 253
F.2d 72, 74, 116
U.S.P.Q. 542 (5th Cir. 1958) (“The
parties agree that compensatory damages, as provided in the statute,
may comprehend the profits of the infringer.”); Zysset
v. Popeil Bros., Inc., 134 U.S.P.Q. 222, 230 (N.D.
Ill. 1962) (“It is well established that a patent owner in a
patent infringement action is entitled to recover the profits which
the infringer has made by reason of his infringement.”); but
seeRic-Wil Co. v. E.B. Kaiser Co., 179 F.2d 401, 407-08, 84 U.S.P.Q. 121 (7th Cir.
1950) (reversing award of accounting for profits because 1946 Act
eliminated reference to infringer's profits, so “profits realized
by an infringer are not recoverable as such.”).
In
patent nomenclature what the infringer makes is “profits”;
what the owner of the patent loses by such infringement is “damages.”
Profits and damages have traditionally been all-inclusive as the two
basic elements of recovery. Prior to 1946, the statutory precursor
of the present §284 allowed recovery of both amounts …
. By the 1946 amendment, … the statute was changed to approximately
its present form, whereby only “damages” are recoverable.
The purpose of the change was precisely to eliminate the recovery
of profits as such and allow recovery of damages only… . There
can be no doubt that the amendment succeeded in effectuating this
purpose; it is clear that under the present statute only damages are
recoverable.
…
But the present statutory rule is that only “damages”
may be recovered. These have been defined by this Court as “compensation
for the pecuniary loss [the patentee] has suffered from the infringement,
without regard to the question whether the defendant has gained or
lost by his unlawful acts.” They have been said to constitute “the
difference between his pecuniary condition after the infringement,
and what his condition would have been if the infringement had not
occurred.” The question to be asked in determining damages is “how
much had the Patent Holder and Licensee suffered by the infringement.
And that question [is] primarily: had the infringer not infringed,
what would the Patent Holder-Licensee have made?”
18
18 Id. at 479-80 (citations omitted).
That
the patentee no longer can recover the infringer's profits “as
such” does not mean that those profits are irrelevant to all
reasonable royalty analyses or that the patentee's recovery cannot
be a portion of the infringer's profits. Which form of the infringer's
profit, if any, may be relevant, and how that profit may be relevant,
however, depends on the analysis under which the reasonable royalty
is determined.
Today,
the reasonable royalty damages analysis most commonly takes the form
of a “hypothetical negotiation” or “willing buyer-willing
seller” methodology, in which the trier of fact determines what
a willing licensee in the place of the infringer reasonably would
have paid and what a willing licensor in the place of the patentee
reasonably would have accepted for the grant of a license under the
patent in suit, if such a license had been negotiated before the infringement
began.
19
This approach assumes that both parties
reasonably wished to enter into a license and that both parties conducted
the negotiation based on the understanding that the patent was valid,
enforceable and infringed.
20
19 Lucent Techs.,
Inc. v. Gateway Inc., 580
F.3d 1301, 1325, 2009
BL 193956, 92
U.S.P.Q.2d 1555 (Fed. Cir. 2009) (175 PTD, 9/14/09) (“The
hypothetical negotiation tries, as best as possible, to create the ex
ante licensing negotiation scenario and to describe the resulting
agreement.”); see alsoHorvath v. McCord
Radiator & Mfg. Co., 100
F.2d 326, 335 (6th Cir. 1938) (“In fixing damages
on a royalty basis against an infringer, the sum allowed should be
reasonable and that which would be accepted by a prudent licensee
who wished to obtain a license but was not so compelled and a prudent
patentee, who wished to grant a license but was not so compelled.”).
20 Rite Hite Corp.
v. Kelley Co., 56 F.3d
1538, 1554, 35
U.S.P.Q.2d 1065 (Fed. Cir. 1995) (en
banc); Lucent v. Gateway, 580 F.3d at 1325.
The
first step in this analysis is to determine when the asserted infringement
began, because the hypothetical license would have been negotiated
before initiation of the infringing activity.
21
Reasonable royalty damages are not based
on a hindsight evaluation of what happened, but on what the parties
to the hypothetical license negotiations would have agreed before
the infringement began.
22
21 Integra Lifesciences
I, Ltd. v. Merck KgaA, 331
F.3d 860, 870, 66
U.S.P.Q.2d 1865 (Fed. Cir. 2003) (hypothetical
negotiation occurs “at a time before the infringing activity
began.”); Lucent v. Gateway, 580 F.3d
at 1324 (hypothetical negotiation takes place “just before infringement
began.”). Although the case law has not addressed the distinction,
the Federal Trade Commission has taken the position that the negotiation
should be deemed to have taken place “at the time the decision
to use the infringing technology was made” in order to prevent
damage awards based on the costs from switching designs after making
investments based on that decision. Federal Trade Commission, The
Evolving IP Marketplace: Aligning Patent Notice And Remedies With
Competition 189-91 (2011).
22 LaserDynamics
v. Quanta Computer, Inc., 694
F.3d 51, 75, 2012
BL 222195, 104
U.S.P.Q.2d 1573 (Fed. Cir.2012) (172 PTD, 9/6/12) (reasonable
royalty determination must relate to the time infringement occurred
and “not be an after-the-fact assessment”); Powell
v. Home Depot U.S.A., Inc., 663 F.3d 1221, 1238, 100 U.S.P.Q.2d 1742 (Fed.
Cir. 2011) (221 PTD, 11/16/11)
(same); see also Fromson v. Western Litho Plate & Supply
Co., 853 F.2d 1568,
1575, 7 U.S.P.Q.2d 1606 (Fed.
Cir. 1988) (hypothetical negotiation analysis “requires a court
to imagine what warring parties would have agreed to as willing negotiators,”
and in some cases allows the “court to look at events and facts
that occurred thereafter and that could not have been known to or
predicted by the hypothesized negotiators” in order to “bring
out and expose to light the elements of value that were there from
the beginning,” but “not to charge the offender with elements
of value non-existent at the time of his offense.”).
The
second step in a hypothetical negotiation reasonable royalty analysis
is to determine what royalty the parties to the hypothetical negotiation
would have agreed upon as of the negotiation date. This requires determining
not only the form of royalty the parties would have agreed upon—a
single, lump sum license payment, for example, or a running royalty
based on ongoing sales or usage—but also the amount of the royalty.
23
The
hypothetical negotiation reasonable royalty analysis may consider
a wide range of evidence, and some of the factors to which that evidence
may relate are referred to as the Georgia-Pacific factors,
after the district court opinion that set out the analytical framework.
24
They include a threshold factor and 13
evidentiary factors (plus a 15th “factor” that effectively
restates the analytical framework), which the Georgia-Pacific trial
court compiled from a “conspectus of the leading cases”
and described as “seemingly more pertinent” to the issue.
25
These factors,
however, are not exclusive.
26
Moreover, “there is no formula by
which these factors can be rated precisely in the order of their relative
importance or by which their economic significance can be automatically
transduced into their pecuniary equivalent.”
27
24 SeeGeorgia-Pacific
Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120–21, 166 U.S.P.Q. 235 (S.D.N.Y. 1970), rev'd
in part, 446 F.2d 295, 170 U.S.P.Q. 369 (2d
Cir. 1971); Whitserve, LLC v. Computer Packages, Inc., 694 F.3d 10, 26-27, 104 U.S.P.Q.2d 1024 (Fed.
Cir. 2012) (162 PTD, 8/22/12)
(Georgia-Pacific factors are “meant to
provide a reasoned economic framework” for a hypothetical negotiation); Energy
Transp. Group, Inc. v. William Demant Holding A/S, 697 F.3d 1342, 1357, 105 U.S.P.Q.2d 1061 (Fed.
Cir. 2012) (200 PTD, 10/17/12)
(“this court does not endorse Georgia-Pacific as
setting forth a test for royalty calculations, but only as a list
of admissible factors informing a reliable economic analysis.”); Uniloc
USA Inc. v. Microsoft Corp., 632 F.3d 1292, 1317, 2011 BL 1830, 98 U.S.P.Q.2d 1203 (Fed. Cir.
2011) (03
PTD, 1/5/11) (“[T]his court has sanctioned
the use of the Georgia-Pacific factors to frame
the reasonable royalty inquiry. Those factors properly tie the reasonable
royalty calculation to the facts of the hypothetical negotiation at
issue.”); ResQNet.com, Inc. v.
Lansa, Inc., 594 F.3d
860, 869, 2010
BL 24667, 93
U.S.P.Q.2d 1553 (Fed. Cir. 2010) (25 PTD, 2/9/10) (Georgia-Pacific factors
are a “comprehensive (but unprioritized and often overlapping)
list of relevant factors for a reasonable royalty calculation”).
25 Georgia-Pacific, 318
F. Supp. at 1120.
26 Other factors not enumerated in Georgia-Pacific may
be relevant to the royalty determination. For example, the cumulative
effect of “stacking royalties”—the number of patent
licenses required to produce the accused product—may color the
character of a hypothetical negotiation. Integra v. Merck,
331 F.3d at 871-72. In addition, where the patent in suit was transferred
(along with products, other patents and know-how, or other assets)
as part of a business acquisition, the overall acquisition price may
be relevant in assessing the value of a license to the patent. Id.
27 Georgia-Pacific, 318
F. Supp. at 1121.
The
infringer's profits may be relevant to the Georgia-Pacific reasonable
royalty hypothetical negotiation
28
in
two ways.
29
But
before addressing how infringer's profits may be relevant, it also
is important to keep in mind how they are not relevant.
28 The infringer's profits also may be relevant
to the lost profits analysis “for comparison purposes
with the patentee's proof of his lost profits.” Kori
v. Wilco, 761 F.2d at 655.
29 Georgia-Pacific, 318
F. Supp. at 1120, 1127-29.
Georgia-Pacific Factor
8, “[t]he established profitability of the product made under
the patent … ,”
30
does not refer to the infringer's profit,
but instead is directed at the established profitability of the patentee's product,
if the patentee does in fact sell a product.
31
The patentee's product is that which is “made under
the patent,” and its profitability is relevant because “the
more popular and profitable the product sold by the [patentee] that
is covered by the patent, the more the [infringer] would have paid
to license that patent to use in its own product.”
32
30 Id. at 1120.
31 The Georgia-Pacific district
court opinion devoted considerable analysis to this issue. Id.
at 1127-29 (“What must be considered now as one of the elements, inter
alia, relevant to the determination of the reasonable royalty,
is the rate of profits that [the patentee] was making on [its patented
product] at the time [the infringer] began its infringement …,
profits that [the patentee] made and was making on and before [the
hypothetical negotiation date] and that it reasonably anticipated
it would continue to make ….”). Nonetheless, in Finjan,
Inc. v. Secure Computing Corp., 626 F.3d 1197, 1171, 97 U.S.P.Q.2d 1161 (Fed.
Cir. 2010) (214 PTD, 11/8/10),
the Federal Circuit analyzed the infringer's profit in terms of factor
8:
Defendants
disagree most with Parr's analysis of Georgia-Pacific factor
8: “The established profitability of the product made under
the patent; its commercial success; and its current popularity.”
318 F. Supp. at 1120. Under this factor, a wide profit margin
for accused products supports a higher reasonable royalty. E.g.,Lucent,
580 F.3d at 1335.
The Lucent passage
on which the Finjan Court relies says only “Factor
8, the profitability of the product made, supports a higher versus
a lower reasonable royalty, given the unrebutted evidence that the
products at issue are sold with an approximately 70-80% profit margin.”
580 F.3d at 1335. That the patentee's expert in one or more Federal
Circuit cases has analyzed the infringer's profits under Georgia-Pacific factor
8 does not make the one relevant to the other.
32 Richard F. Cauley, Winning
the Patent Damages Case 97 (2009).
The
infringer's profit also is generally not relevant to Georgia-Pacific Factor
11, “The extent to which the infringer has made use of the invention;
and any evidence probative of the value of that use.”
33
Factor 11
traditionally applies to facts such as the number of instances of
the infringer's use of the patented invention, the portion of the
infringer's sales that implement the patented invention, as well as
any direct evidence of the value of that use in ways other than profit
directly attributable to the infringing use.
34
In rare instances where the patented feature
creates the customer demand for the infringing product or service,
as in the Georgia-Pacific case itself, Factor
13 allows the infringer's profit to provide evidence of the value
of the infringer's use of the patented invention.
33 Georgia-Pacific, 318
F. Supp. at 1120.
34 As the Georgia-Pacific trial
court explained, “If [the infringer] had been negotiating with
[the patentee] for a license, [it] would have taken into consideration
all advantages that might accrue to it in determining a royalty which
it would be willing to pay,” including that a “license
to sell the patented striated fir plywood would have enabled [the
infringer] to expand its business, increase its sales of non-infringing
materials and thereby increase its profits.”
The
first way in which the infringer's profit may be relevant
to the hypothetical negotiation is through Georgia-Pacific Factor
12, “the portion of profit that may be customarily allowed in
the particular business for the use of the invention or similar inventions.”
35
In view of the Federal Circuit's focus
on tethering the damages to the facts and circumstances of the present
case as opposed to industry data,
36
analysis of the infringer's profit under
this factor should become relevant only where one or both of the parties
to the hypothetical negotiation has entered into a patent license
agreement in which a patent has been licensed in exchange for a royalty
calculated as a portion of the infringer's profit.
37
And while such circumstances are relatively rare because
of the practical difficulties caused by licensing based on a percentage
of the licensee's profits,
38
they do occur, most
commonly in the pharmaceutical and medical devices fields.
39
35 In Uniloc, 632 F.3d
at 1317-18, the court explained that Georgia-Pacific “factor
12—looking at the portion of profit that may be customarily
allowed in the particular business for the use of the invention or
similar inventions—[remains a] valid and important factor []
in the determination of a reasonable royalty rate.” Consideration
of this factor often includes third party licenses that do not fit
under factors 1 (“royalties received by the patentee for the
licensing of the patent in suit, proving or tending to prove an established
royalty”) and 2 (“rates paid by the licensee for the use
of other patents comparable to the patent in suit”).
36 SeeUniloc,
632 F.3d at 1318; Multimedia Patent Trust v. Apple, Inc.,
No. 10-cv-2618, 2012 BL 306087,
slip op. at 10 (S.D. Cal. Nov. 20, 2012) (excluding testimony on “generic
industry data” as “not tethered to the relevant facts
and circumstances of the present case); Oracle Am., Inc.
v. Google, Inc., 798
F. Supp. 2d 1111, 1119-21, 2011 BL 191701 (N.D. Cal. 2011)
(rejecting fifty/fifty split because “there is no anchor for
this fifty-percent assumption in the record of actual transactions”).
37 SeeVirnetX, Inc. v.
Cisco Systems, Inc., No. 2013-1489, 2014 BL 256078, slip op. at 38-41
(Fed. Cir. Sept. 16, 2014) (180
PTD, 9/17/14) (rejecting a 45%/55% split because
of patentee's expert's failure to establish a fit between the particular
situation and the premises underlying the Nash Bargaining Solution); Uniloc,
632 F.3d at 1318 (rejecting award based on 25% rule where patentee's
expert did not testify that either of the parties “had a practice
of beginning negotiations with a 25%/75% split, or that the contribution
of the [patented feature] to the [accused products] justified such
a split”); Digital Reg of Texas, LLC v. Adobe Sys.,
Inc., No. 12-cv-1971, ECF No. 632, slip op. at 6 (N.D.
Cal. Aug. 19, 2014) (excluding patentee's damages expert's testimony
based on “a 50% split of the saved profits” because he
conceded in deposition “he had not seen an evidence of either
[of the parties] commencing negotiations with a fifty-fifty profit
split”); Suffolk Techs. LLC v. AOL Inc.,
No. 1:12-cv-625, ECF No. 518, slip op. at 4 (E.D. Va. Apr. 12, 2013)
(rejecting patentee's damages expert's testimony based on “50/50
split” where expert “does not explain why these parties
would have accepted a 50/50 split”).
38 The practical difficulties associated with
such an arrangement are cataloged in Davis, supra note
1, at 705-06.
39 See, e.g., Astrazeneca
AB v. Apotex Corp., 985
F. Supp. 2d 452, 2013 BL 333777 (S.D.N.Y. 2013)
(awarding 50% of profits as a reasonable royalty for sales of the
pharmaceutical omeprazole based on evidence of license agreements
requiring 7-40% (presumably) of net revenue and 35-50% of profits,
offers requiring 50% and 70% of profits, and a settlement agreement
equating to 54% of profits).
The
second way in which the infringer's profits may be relevant to the
hypothetical negotiation is through Georgia-Pacific Factor
13, “[t]he portion of the realizable profit that should be credited
to the invention as distinguished from non-patented elements, the
manufacturing process, business risks, or significant features or
improvements added by the infringer.”
40
This factor, the infringer's apportioned profit, should
sound familiar: it is the very measure of damages that Congress eliminated
in 1946. Then why did the Georgia-Pacific opinion—issued
six years after the Aro Court held that the
infringer's apportioned profit was not an available utility patent
infringement remedy—include it in the list of factors considered
in the hypothetical negotiation? The answer lies in Factor 15.
40 318 F. Supp. at 1120.
Factor
15 is not a factor at all, but a restatement of the analytical construct
in which the factors are applied: it references the hypothetical negotiation
taking place between “a licensor (such as the patentee) and
a licensee (such as the infringer)” and characterizes the reasonable
royalty as an amount that “a prudent licensee—who desired,
as a business proposition, to obtain a license to manufacture and
sell a particular article embodying the patented invention—would
have been willing to pay as a royalty and yet be able to make
a reasonable profit … .”
41
The Georgia-Pacific opinion
identifies as one of the circumstances the parties to the hypothetical
negotiation would consider the “anticipated amount of net profits
that the prospective licensee reasonably thinks he will make,”
42
and explains that the suppositious licensee
sitting at the hypothetical negotiating table in the place of accused
infringer would expect to make a reasonable profit from its anticipated
use of the patented invention.
43
In other words, “a [hypothetically
negotiated] reasonable royalty would leave [the suppositious licensee
sitting in place of the] infringer with a reasonable profit.”
44
41 Id. (emphasis added).
42 Id. at 1121. The Georgia-Pacific court
emphasized the distinction between anticipated and actual profits: “GP
is in error when it argues that, because this Court rejected the master's
use of GP's infringing profits as the legal measure of damages, evidence
of GP's reasonably anticipated profits as of 1955 is irrelevant to
the present inquiry.” Id. at 1123. The Georgia-Pacific court
went on to analyze the profits the patentee “would reasonably
have expected to earn.” Id. at 1130.
43 See id. at 1122; Lindemann
Maschinenfabrik GmbH v. American Hoist & Derrick Co., 895 F.2d 1403, 1408, 13 U.S.P.Q.2d 1871 (Fed.
Cir. 1990) (affirming award of damages and rejecting testimony of
patentee's damages expert that reasonable royalty would have exceeded
infringer's anticipated net profit, stating that his “opinion
that [infringer] ‘would agree to pay a royalty in excess of
what it expected to make in profit’ was, in light of all the
evidence in this case, absurd”). See also Daralyn
J. Durie & Mark A. Lemley, A Structured Approach to Calculating
Reasonable Royalties, 14 Lewis & Clark L. Rev. 627, 640
n.57 (2010) (arguing that reasonable royalty should be limited by
the infringer's expected profits) (“Structured Appoach”).
That the infringer may have not expected to make a profit, that is,
planned to make and sell a product or perform a service to garner
market share, to boost sales of convoyed goods, or for another purpose,
does not mean that its expectation is irrelevant, only that the profit
limitation may have little or no effect. In Powell v. Home
Depot, 663 F.3d at 1238-39, where the Federal Circuit
properly rejected the infringer's argument that the reasonable royalty
could not, under the facts of the case, exceed the patentee's expected
profits, the panel went on, gratuitously, to reject the infringer's profit
expectation as a limit on the reasonable royalty, relying solely on
the 1983 opinion in Stickle v. Heublien, Inc., 716 F.2d 1550, 1563, 219 U.S.P.Q. 377 (Fed.
Cir. 1983), which it characterized as “rejecting the accused
infringer's argument that the reasonable royalty is capped by the
sales prices of the patented product.” 663 F.3d at 1239. But
the post-hypothetical negotiation sales price of the product alone
says nothing about the profit expectation of the party to the negotiation.
Based on this inapposite authority, in a case in which the issue does
not appear to have been presented, the Powell panel purported
to eliminate from the reasonable royalty analysis the proper role
of the infringer's expected profit as a limitation on the reasonable
royalty. Because that ruling conflicts with several other Federal
Circuit pronouncements on the issue, including Lindemann,
895 F.2d at 1408, and Hanson v. Alpine Valley Ski Area,
Inc., 718 F.2d 1075,
1081, 219 U.S.P.Q. 679 (Fed.
Cir. 1983), however, the extent to which the infringer's profit expectation
serves to limit the reasonable royalty remains for future Federal
Circuit panels, the Court en banc, or the Supreme Court to decide. SeeNewell
Co. v. Kinney Mfg. Co., 864
F.2d 757, 765, 9 U.S.P.Q.2d 1417 (Fed.
Cir. 1988) (under Federal Circuit precedent, prior decisions are binding
unless and until overturned by the court en banc, and where the court's
precedential decisions conflict, the earlier decision controls).
44 Hanson, 718 F.2d at
1081; see alsoApplied Med. Res. Corp. v. United
States Surgical Corp., 435
F.3d 1356, 1361, 77 U.S.P.Q.2d 1666 (Fed.
Cir. 2006); Trans-World Mfg. Corp. v. Al Nyman & Sons,
Inc., 750 F.2d 1552,
1568, 224 U.S.P.Q. 259 (Fed.
Cir. 1984). Georgia-Pacific aptly uses the
phrase “suppositious licensee” instead of “infringer”
for the party sitting at the hypothetical negotiating table because
that party is not actually the infringer, but someone imbued with
the infringer's knowledge at the time. Likewise, sitting in place
of the patentee would be the “suppositious licensor,”
who might have the knowledge of an entirely different party: the party
that owned the patent at the time of the hypothetical negotiation. See,
e.g., Oracle v. Google, 798 F. Supp.
2d at 1116-17 (patentee at the time, rather than plaintiff that later
acquired the patent, was proper party to hypothetical negotiation), Nichols
Institute v. Scantibodies Clinical Laboratory, No. 3:02-cv-0046-B, 2006 BL 129651, slip op. at 7-10
(S.D. Cal. May 2, 2006) (same); see also generally Samuel
T. Lam, Musical Chairs In Reasonable Royalty Hypothetical Negotiations:
Who Occupies The Seat At The Table Across From The Accused Infringer,
88 BNA Pat. Trademark & Copyright J. 426 (June 6, 2014) (110 PTD, 6/9/14).
An
infringer's actual profit margin may in limited circumstances
be relevant to the determination of a royalty rate in a hypothetical
negotiation.
45
In other words,
the infringer's actual apportioned profits are not always relevant,
but can be relevant under the “Book of Wisdom.”
46
As evidence of the apportioned
profits the party sitting at the negotiation table would have expected
to make from using the invention, evidence of the infringer's actual
post-hypothetical negotiation apportioned profits can be relevant
if the circumstances under which those profits were made were comparable
to what the negotiation party would have foreseen.
47
That an infringer actually made unexpectedly
low profits, or even lost money, from its infringing use may have
little or no relevance, and a reasonable royalty may exceed the infringer's
actual profit.
48
Therefore, the infringer's
actual profits are properly considered as part of a hypothetical negotiation
reasonable royalty analysis only when there were no pre-negotiation
profit projections and the evidence reflects the state of mind of
the parties to the hypothetical negotiation at the time of the negotiation
and does not in itself “create value.”
49
45 SeeInteractive Pictures
Corp. v. Infinite Pictures, Inc., 274 F.3d 1371, 1385, 61 U.S.P.Q.2d 1152 (Fed.
Cir. 2001); Trans-World v. Al Nyman & Sons,
750 F.2d at 1568.
46 See generally Martha K. Gooding, Reasonable
Royalty Patent Damages: A Proper Reading of the Book of Wisdom,
BNA Pat., Trademark & Copyright J. (Apr. 18, 2014) (76 PTD, 4/21/14) (“Proper
Reading”). Some cases have taken the position that the infringer's
actual profits are considered as part of the hypothetical negotiation. See,
e.g., Faulkner v. Gibbs, 199 F.2d 635, 640, 95 U.S.P.Q. 400 (9th Cir.
1952) (affirming award of $15,000 in damages after considering much
evidence, including “largely conjectural” evidence that
the infringer's profits were $36,000 per year for five and one-half
years of operation). The authority on which the Ninth Circuit relied
in Faulkner v. Gibbs, however, predated the
1946 Act and involved an award of infringer's profits for a portion
of the period of infringement and a reasonable royalty of 10% of net
sales during the remainder; the issue was whether the patentee could
establish the basis for an award of the infringer's profits for the
remainder by relying on the profits of a competitor. SeeAutographic
Register Co. v. Sturgis Register Co., 110 F.2d 883, 886, 45 U.S.P.Q. 58 (6th Cir.
1940).
47 SeeFinjan,
626 F.3d at 1210 (The patentee's expert's “use of the actual
profit margins that both [the patentee and infringer] experience on
products after [the hypothetical negotiation] date was simply as a
reflection of the profits the parties might have anticipated in calculating
a royalty in the hypothetical negotiation.”).
48 SeeDouglas Dynamics,
LLC v. Buyers Prods. Co., 717
F.3d 1336, 1346 (Fed. Cir. 2013) (vacating reasonable
royalty award that trial court limited to infringer's actual profit
margins); Golight, Inc. v. Wal-Mart Stores, Inc., 355 F.3d 1327, 1338-39, 69 U.S.P.Q.2d 1481 (Fed.
Cir. 2004) (affirming royalty award where infringer's evidence of
projected profits was “sparse”); see also Radio
Steel & Mfg. Co. v. MTD Prods., Inc., 788 F.2d 1554, 1557, 229 U.S.P.Q. 431 (Fed.
Cir. 1986) (affirming royalty that exceeded the profits where infringer's
treasurer testified infringing products “might have been utilized
as loss-leaders at various times during the period of infringement”); Hanson,
718 F.2d at 1081 (“Whether, as events unfurled thereafter, [infringer]
would have made an actual profit, while paying the royalty determined
as of [the hypothetical negotiation date] is irrelevant.” (internal
citation and quotation marks omitted)). Likewise, there is no rule
that a reasonable royalty should be capped by a patentee's expected
profit margin. Powell v. Home Depot, 663 F.3d
at 1238.
One
final caveat, to be relevant under Georgia-Pacific Factor
13, the infringer's profit must be apportioned to separate the profit
attributable to the patented feature from that of all the other features
and other bases for profit.
50
In other words, to be used in the reasonable royalty analysis,
the infringer's profit must be apportioned.
50 AccordVirnetX,
slip op. at 40 (noting that the Nash Bargaining Solution offers a “noticeable
improvement over the 25% rule” by focusing “only on the incremental profits
earned by the infringer from the use of the asserted patents,”
which “more appropriately (and narrowly) defines the universe
of profits to be split … .”).
The Analytical Method
In
a case dealing with the hypothetical negotiation reasonable royalty,
the Federal Circuit suggested in Lucent Technologies, Inc.
v. Gateway, Inc. that there is a way to determine reasonable
royalty patent infringement damages that is separate from the hypothetical
negotiation approach.
51
This approach, which
the Court called the “analytical method,” “focuses
on the infringer's projections of profit for the infringing product.”
52
51 580 F.3d
1301, 1324 (Fed. Cir. 2009). The Court did not mention
a third approach to determining patent damages, the established royalty. See
generally William C. Rooklidge, Martha K. Gooding, Philip S.
Johnson & Mallun Yen, Compensatory Damages Issue in Patent
Infringement Cases: A Pocket Guide for Federal District Court Judges at
5-7 (Federal Judicial Center 2011) (“Although sometimes characterized
as a reasonable royalty, the established royalty is, strictly speaking,
a form of actual damages, and is ‘reasonable’ in the sense
that it typically provides the ‘best measure’ of a royalty
for the use made of the invention.” (citing Monsanto
Co. v. McFarling, 488
F.3d 973, 978, 82 U.S.P.Q.2d 1942 (Fed.
Cir. 2007)).
52 Lucent v. Gateway, 580
F.3d at 1324. Martha K. Gooding, Analyzing the Analytical Method
of Calculating Reasonable Royalty Patent Damages, 84 BNA Pat.,
Trademark & Copyright J. 78 (May 11, 2012) (92 PTD, 5/14/12), reviews
the cases on which the Lucent Court relied,
and explains that the supposed “analytical method” (or “analytical
approach”) should not be viewed as a damages methodology independent
of the Georgia-Pacific hypothetical negotiation
approach. The cases on which the Lucent opinion
relies certainly purported to apply Georgia-Pacific‘s
willing-buyer/willing-seller hypothetical negotiation approach. See
infra notes 72 and 83 and accompanying text. Contemporary opinions,
however, view the approaches as entirely distinct. See, e.g., Linear
Group Servs., LLC v. Attica Automation, Inc., No. 13-cv-10108, 2014 BL 247506, slip op. at 15
(E.D. Mich. Aug. 25, 2014) (“the analytical method focuses on
the infringer's projections of profit or the infringing product, regardless
of what the parties might have hypothetically agreed to had they successfully
negotiated before the infringement began,” citing TWM,
789 F.2d at 899).
The
case cited as the wellspring of the “analytical method”
is the Federal Circuit's 28-year old opinion in TWM Mfg.
Co. v. Dura Corp.,
53
which affirmed a reasonable
royalty damages award by a lower court that, in turn, had relied on Georgia-Pacific and Tektronix,
Inc. v. United States.
54
As we shall see, the
Federal Circuit's analysis in TWM, as well
as the Court of Claims' analysis in Tektronix on
which the TWM Court relied, are
fundamentally flawed. The opinions that have applied the “analytical
method” as a stand-alone alternative to the hypothetical negotiation
damages calculation have misused the infringer's anticipated profits
attributable to the patented feature in three ways, by: (1) ignoring
that the infringer's anticipated profits properly serve only to cap
the hypothetical negotiation reasonable royalty; (2) failing to apply
anything approaching rigorous apportionment, the requirement of which
led to Congress' rejection of the profits remedy in the first place;
and (3) when using actual, instead of anticipated, profits under the
Book of Wisdom, awarding those infringer's apportioned profits or
a proxy even though that remedy long ago was rejected by Congress.
These failings, however, become most apparent after reviewing the
district court and appellate court opinions in Georgia-Pacific,
as well as their progeny.
The Trial Court and the Second Circuit's Georgia-Pacific
The Georgia-Pacific district
court reviewed the facts in the context of the framework established
by its list of factors, and then “attempted to exercise a discriminating
judgment reflecting its ultimate appraisal of all pertinent factors
in the context of the credible evidence.”
55
According to the Court, particularly relevant facts included:
the lack of an established royalty;
56
the patentee's policy to maintain a monopoly; the infringer's
status as a competitor; the lack of competitive products (except the
infringer's later product);
57
the popularity and profitability of the
patentee's product, both by itself and from collateral sales;
58
the infringer's perception of the infringing
product as highly profitable, both by itself and due to “substantial
additional profits” from collateral sales;
59
and the patented invention contributing “substantially
the entire value to the structure represented by the infringing article.”
60
Faced with no evidence of royalties in
comparable circumstances,
61
the district court relied on the testimony
of the patentee's expert witnesses to find that the patentee's established
profit was $48 per thousand square feet of product, that the infringer
expected to profit from the infringing product “at least approximately
the same rate” and to make more profit on the collateral sales,
and that the reasonable royalty was $50 per thousand square feet of
product. That royalty, the district court found, would have enabled
the infringer “to realize a substantial profit,” even
apart from its profit on collateral sales.
62
The Georgia-Pacific district court
hastened to point out, however, that its finding was “derived
from a close factual analysis of the total record,” and to the
extent the court relied on precedential guidance, the precedent was “subjected
to the qualifications and modifications required by a realistic comparison
of the particular facts and individual circumstances in the prior
decisions and those in the case at bar.”
63
55 318 F. Supp. at 1121.
56 Id.
57 Id. at 1123-25.
58 Id. at 1125-30.
59 Id. at 1131-32.
60 Id. at 1132-37.
61 Id. at 1137-40.
62 Id. at 1143.
63 Id.
Perhaps
more important than the analysis the district court did adopt
was the analysis it did not adopt. The infringer had
argued that it would have been willing to split evenly with the patentee
what it estimated as its roughly $50 per thousand square feet expected
profit from the sale of the product only (ignoring the profit on the
collateral sales) and that negotiations would have led to agreement
at the midpoint between the suppositious licensee's $25 initial position
and the $50 that the patentee's experts testified the patentee would
have found acceptable, for a final royalty rate of $37.50 per thousand
square feet.
64
The district court rejected this testimony
as being “at odds with the preponderant weight of the credible
evidence.”
65
In other words, the trial court rejected the profit-split
analysis and instead relied on an analysis heavily dependent on all
the facts and circumstances as informed by the factors drawn from
the case law.
On
appeal, the Second Circuit parted ways with the district court on
the effect of the unquantified profit on the collateral sales, and
held that the trial court had erred by failing to apply the suppositious
licensee's expected profit as a limitation because “the royalty
imposed … gobbles up all of [the suppositious licensee's] expected
profit.”
66
According to the appellate court, the
trial court's “failure to quantify leaves us no recourse but
to ignore profits on collateral sales or to assume that such profits
were taken into account in arriving at the $50 figure for [the suppositious
licensee's] reasonably expected profits”—and it chose
the latter.
67
Because the error left the suppositious
licensee with no profit, the appellate court subtracted the infringer's
9% actual “average net profit on sales of all products over
the period of infringement” from the infringer's actual “average
realization” to achieve a $35.65 royalty, and it reduced the
trial court's award accordingly.
68
The
Second Circuit properly considered evidence of the suppositious licensee's
expected profit to fashion a cap on the reasonable royalty, that is,
to fix the royalty “so as to leave the infringer, or suppositious
licensee, a reasonable profit.”
69
66 Georgia-Pacific Corp. v. U.S. Plywood-Champion
Papers, Inc., 446 F.2d
295, 299, 170
U.S.P.Q. 369 (2d Cir. 1971).
67 Id. at 299 n.2.
68 Id. at 299-300, 302. The Second
Circuit explained its arrogation of the trial court's role in failing
to remand after identifying the trial court's failure to allow the
infringer a reasonable profit by referring to the “extraordinary
length of time this litigation has already lingered and the willingness
of the party ultimately paying the damages to have us dispose of the
case.” Id. at 299.
69 Id. at 299.
The Court of Claims' Tektronix
In Tektronix,
the seven-judge Court of Claims, sitting en banc, reviewed a trial
judge's award of reasonable compensation for the Government's infringement
of eight patents related to oscilloscopes.
70
The
infringer argued in favor of a sliding-scale, established royalty
based on the sales price of the scopes, relying on licensing practices
of other companies in the “commercial electronics field.”
71
The patentee sought lost profits for some of the infringing
sales, and for the remainder contended that “compensation must
be determined by adopting a reasonable royalty based on a willing-buyer/willing-seller
concept as enunciated in Georgia-Pacific Corp. v. U.S.
Plywood-Champion Papers, Inc.”
72
The trial judge had concluded that “the
best method of computing compensation in this case is to adopt the
approach of establishing a reasonable royalty,” as “exemplified
by the Georgia-Pacific case, … involv[ing]
a willing-buyer/willing-seller concept, in which a suppositious meeting
between the patent owner and the prospective manufacturer of the infringing
item is held to negotiate a license agreement” for the accused
products.
73
The appellate court explained:
70 The patentee's compensation was based on the
statute applicable to determining damages in an infringement action
brought against the United States. See28 U.S.C. §1498 (where the
United States uses or manufactures a patented invention without license,
the patentee's remedy is “reasonable and entire compensation
for such use and manufacture”).
71 552 F.2d at 346.
72 Id. at 346 (citation omitted).
73 Id. at 348-49.
The
negotiation formula which the trial judge borrowed from Georgia-Pacific is,
as already mentioned, to start with the infringer's selling price,
deduct its costs in order to find its gross profit, then allocate
to the infringer its normal profit, and end up with the residual share
of the gross profit which can be assigned to the patentee as its royalty.
74
74 Id.
In
other words, the Tektronix trial court skipped
the Georgia-Pacific trial court's multi-factor
reasonable royalty analysis and proceeded straight to the Georgia-Pacific appellate
court's application of the limit on that reasonable royalty as the “beginning
of [its] suppositious negotiation,” and used that limit to set
the residual profit as the reasonable royalty. Like others that would
follow,
75
the Tektronix trial
court failed to recognize that the Georgia-Pacific appellate
court's analysis did not supplant that of the trial court, but instead
modified the trial court's analysis by applying a cap.
75 See Laura B. Pincus, The
Computation of Damages in Patent Infringement Actions, 5 Harv.
J. of L. & Tech. 95, 126 (1991) (“In Georgia-Pacific,
the circuit court entirely neglected to utilize the fifteen-factor
analysis recommended by the district court,” but instead “looked
only to the profitability of the product and awarded that profit to
the patent holder.”).
And
the Tektronix trial court made another error:
It made no finding that the patented features, like the grooves in
the infringing plywood in Georgia-Pacific,
gave the infringing oscilloscopes their “entire value.”
Without that finding, the “residual share” of the profit
could and likely did contain profit attributable not to the patented
features, but to “non-patented elements, the manufacturing process,
business risks, or significant features or improvements added by the
infringer.”
76
That was
error because “the contribution of any particular patent or
feature should be considered in the context of the often vast patent
landscape that is relevant to the product as well as the contribution
of the other product features.”
77
76 Georgia-Pacific, 318
F. Supp. at 1120.
77 James E. Malackowski, Justin Lewis & Robert
Mazur, New Emphasis on the Analytical Approach of Apportionment In
Determination of a Reasonable Royalty, http://www.visiond.com/aipla/midwinter2013/materials/Malackowski_Paper.pdf,
at 6 (2013).
The Tektronix appellate
court accepted the trial court's general approach, but modified the
calculation in two respects. First, it concluded that the trial court's
calculation understated the infringer's manufacturing costs and therefore
inflated what it called the infringer's “residual share.”
78
Second, after correcting the residual share to 7.65% of
the unit price, the Court concluded that, on the facts before it,
a reasonable patentee would have insisted upon (and a reasonable licensee
would have been willing to pay) a royalty somewhat higher than the
7.65% residual profit.
79
Accordingly, the Tektronix appellate
court found 10% to be the proper royalty rate, noting that that rate
represented its best judgment of “what the parties would have
agreed upon, if both were reasonably trying to reach an agreement.”
80
In short, the Tektronix appellate
court doubled down on the trial court's errors, not only by using
the residual profit as a basis for the reasonable royalty calculation
itself, but by imposing a reasonable royalty rate even higher than
the residual profit, so that the infringer was left with less than
a reasonable profit.
78 552 F.2d at 350.
79 Id. at 350-51. Distinguishing Tektronix,
one court decided that “no upward adjustment is warranted, even
though [the patentee] achieved a 19% profit, i.e., more
than four times higher than the residual profit on [the infringing]
sales” because “unlike the patentee in Tektronix,
[the patentee here] did not offer any evidence that it took the risks
and bore the expense of developing the [infringing products] and creating
a market for them … .” Honeywell Int'l Inc.
v. United States, 107 Fed. Cl. 659, 693, 2012 BL 317245 (Fed. Cl. 2012).
80 Id. at 352 (citation omitted).
Per the Court, the patentee would not have been entitled to its own
25% profit margin as a reasonable royalty because “[a] portion
of that 25% profit represented compensation, not for the patented
idea itself, but for the efficiencies and risks of manufacture as
well as the investment of other capital,” a portion “separate
and apart from any compensation due it for use of its patents.” Id.
at 350-51.
The Federal Circuit's TWM
v. Dura
In TWM
v. Dura, the Federal Circuit affirmed a patent infringement
damages award that had been crafted by a magistrate sitting as a special
master and then adopted in its entirety by the district court.
81
The award included
amounts for lost profits, a reasonable royalty (for sales where lost
profits could not be proven), price erosion and enhanced damages.
82
Then-Chief Judge Markey
noted that, “[f]or the years TWM could not establish its lost
profits, [the parties] agreed that the district court should determine
a reasonable royalty based on a ‘hypothetical royalty resulting
from arm's length negotiations between a willing licensor and a willing
licensee.’”
83
The
magistrate ostensibly relied on the “willing licensor/willing
licensee” method, citing Tektronix and Georgia-Pacific,
84
but especially relied on
the Tektronix trial court's analysis in arriving
at the 30% reasonable royalty award:
81 789 F.2d at 898. The trial court made a minor
modification to the magistrate's report to add a case citation, but
otherwise adopted the magistrate's report in its entirety, concluding
that it contained no errors of law and the findings of fact were not
clearly erroneous. SeeTWM Mfg. Co. v. Dura
Corp., 231
U.S.P.Q. 525, 526 (E.D.
Mich. 1985).
82 TWM v. Dura, 789 F.2d
at 898.
83 Id. (citing Hanson,
718 F.2d at 1078; Tektronix, 552 F.2d at 348-49; Georgia-Pacific,
318 F. Supp. at 1120-22).
84 TWM v. Dura, 789 F.2d
at 899.
The
[magistrate], citing Georgia-Pacific and Tektronix,
used the so-called “analytical approach,” in which she
subtracted the infringer's usual or acceptable net profit from its
anticipated net profit realized from sales of infringing devices.
Relying principally on a memorandum written by “[the
infringer's] top management” before the initial infringement,
the special master found that [the infringer] projected a gross profit
averaging 52.7% from its infringing sales. From that figure, she subtracted
overhead expenses to get an anticipated net profit in the range of
37% to 42%. Subtracting the industry standard net profit of 6.56 %
to 12.5% from that anticipated net profit range, she arrived at a
30% reasonable royalty.
85
85 Id. The magistrate had explained:
For
the reasons stated below this Magistrate agrees that the analytical
approach cited in Georgia-Pacific, supra,
and Tektronix, supra, is appropriate
to the case at bar. The Magistrate further agrees that during the
critical period, given the record in this case, a willing buyer and
willing seller would have entered into a royalty of at least 30% of
the invoice price of the infringing device. This analytical approach
takes the anticipated net profit realized by the infringer from sales
of the infringing device and subtracts the usual or acceptable net
profit of the infringer. Then the result is analyzed to be sure it
constitutes adequate compensation. This approach is imminently [sic]
fair to [the infringer] since it awards … the infringer a normally
acceptable profit on the lift suspension, while giving the remainder
as a royalty to the patentee.
TWM
v. Dura, 231 U.S.P.Q.
at 527-29 (citations omitted).
TWM
v. Dura presented unusual facts in that, like the grooved
plywood of Georgia-Pacific, the patented feature
in TWM v. Dura created the customer demand
for the entire device.
86
Moreover, instead of challenging the trial court's use
of the industry standard profit, the infringer challenged use of an
internal memorandum identifying the infringer's profit expectation
for the infringing product. Despite these unusual facts, to the extent
deducting the “standard profit” from the profit expectations
served as a rough proxy for the profit attributable to the patented
feature, the resulting value should not have been awarded as damages:
It should have been used only as a cap. Because the accused infringer
did not raise this argument, and because of the unusual facts, however, TWM
v. Dura is less than helpful precedent for proper application
of the analytical method.
87
86 789 F.2d at 901.
87 Malackowski, Lewis & Mazur, supra note
77, at 2-3 (citations omitted), explains:
Early
case law such as Georgia-Pacific and TWM involved
asserted patented technologies which were deemed to contribute virtually
the entire incremental difference in profits between the accused and
non-accused products. In such instances, a further apportionment was
not needed… .
With today's feature rich products this single
feature Analytical Approach is rarely the case. Recent case law has
recognized that it is often the case in today's complex litigation
where there are a multitude of non-accused incremental features which
contribute to the generation of profits for an accused product. Under
these circumstances a further apportionment of the incremental profits
is necessary.
The Federal Circuit's Lucent v.
Gateway
The
opinion most often cited today in connection with the analytical method
is the 2009 Federal Circuit opinion in Lucent v. Gateway.
88
As part of a general,
introductory discussion of damages—including citations to the
damages statute, the compensatory purpose of the statute, the burden
of proof, and the availability of lost profits or royalty damages—the
court noted that “litigants routinely adopt several approaches
for calculating a reasonable royalty”: the “analytical
method” and the “hypothetical negotiation” approach.
89
The Court went on to explain:
The
first [approach], the analytical method, focuses on the infringer's
projections of profit for the infringing product. SeeTWM
Mfg. Co. v. Dura Corp., 789
F.2d 895, 899 (Fed. Cir. 1986) (describing the analytical
method as “subtract[ing] the infringer's usual or acceptable
net profit from its anticipated net profit realized from sales of
infringing devices”); see also John Skenyon et
al., Patent Damages Law & Practice §3:4, at
3-9 to 3-10 (describing the analytical method as “calculating
damages based on the infringer's own internal profit projections for
the infringing item at the time the infringement began, and then apportioning
the projected profits between the patent owner and the infringer”).
90
90 Id.
Because Lucent
v. Gateway did not involve application of the analytical
method, the Court's description of the approach is dictum, and the
analytical method was not the subject of further discussion or analysis
in the opinion.
91
The Court's reference to the analytical
method is, nevertheless, noteworthy. The two definitions of the analytical
method cited by the Court are not the same: one is simply a mathematical
exercise to determine the infringer's anticipated incremental profits
on the accused product over its usual profit, and the other requires
some kind of apportionment of the infringer's anticipated profits
for the accused products. Evaluating both formulations in light of
current Federal Circuit damages law reveals flaws in both.
91 This Lucent v. Gateway dictum
has found its way, without analysis, into dicta in later opinions. See,
e.g., Wordtech Sys. Inc. v. Integrated
Networks Solutions Inc., 609
F.3d 1308, 1319, 2010
BL 135032, 95
U.S.P.Q.2d 1619 (Fed. Cir. 2010) (117 PTD, 6/21/10) (“A
reasonable royalty can be calculated from an established royalty,
the infringer's profit projections for infringing sales, or a hypothetical
negotiation between the patentee and infringer based on the [Georgia-Pacific]
factors … .”); Oracle America, Inc. v. Google,
Inc., No. 3:10-cv-3561, ECF No. 352, slip op. at 1 (N.D.
Cal. Aug. 23, 2011) (analytical method for determining a reasonable
royalty calculates damages based on infringer's internal profit projections
for the infringing item at the time infringement began and then apportions
projected profits between patentee and infringer).
The “Residual-Profits” Version
of the “Analytical Approach”
Lucent
v. Gateway’s first analytical approach formulation
is a simple mathematical exercise: the reasonable royalty for infringement
equals (1) the net profit the infringer expected to realize from the
sales of the infringing product minus (2) the infringer's usual or
acceptable net profits.
92
This “residual-profits”
formulation, which is the same as the limit applied by the Georgia-Pacific appellate
court, is “based on the premise that any rate of return in excess
of a normal rate of return can be attributed to the patent.”
93
In other words, the
residual profits serve as a proxy for the apportioned share of the
anticipated profits attributable to the infringer's use of the patented
feature. Indeed, because this approach is the roughest of proxies,
it suffers from the same three overriding flaws that caused the Federal
Circuit in Uniloc v. Microsoft to sound the
death knell for the 25% rule of thumb.
94
92 Lucent v. Gateway, 580
F.3d at 1324. The deficiencies of this approach catalogued here do
not begin to account for the deficiencies as applied in patent infringement
testimony, where concepts like “industry standard net profit”
and the infringer's “normal profit” are employed. Suffice
it to say that profit numbers based on sales by other industry participants
or of the infringer's other products can involve technology and market
conditions completely unlike that of the accused product or process.
Further, the profit margins often times are calculated on inconsistent
bases. See, e.g., Johns-Manville Corp. v.
Guardian Indus. Corp., 718
F. Supp. 1310, 1313-14 (E.D. Mich. 1989) (rejecting
analytical method analysis that, among other faults, “improperly
mixes cost accounting with financial accounting by using plant-level
numbers to derive certain figures and annual report numbers to obtain
allegedly comparative figures”).
93 Fresenius Med. Care Holdings, Inc.
v. Baxter Int'l, Inc., No. 3-cv-1431, 2006 BL 61077, slip op. at 10
(N.D. Cal. May 18, 2006) (denying motion to exclude expert damages
report based on different methods of calculating reasonable royalty,
including the “analytical method,” and explaining “[t]his
method takes the profits of the infringer, subtracts the infringer's
normal profit, and awards some portion of the remainder to the patent
owner”).
First,
mechanically awarding all the “residual” profit (above
the infringer's “usual” or “acceptable” profit)
to the patentee as a reasonable royalty “fails to account for
the unique relationship between the patent and the accused product.”
95
It assumes that every penny of residual
anticipated profit would be attributable solely to the patented invention.
It therefore makes no attempt to account for the importance of the
infringed technology in generating those profits and does not reflect “the
invention's contribution to the infringing product or service.”
96
It is easy to imagine an accused product that incorporates
a number of valuable features or technologies that were not included
in the infringer's prior product lines, only one of which is the patented
feature. Likewise, the accused product may well benefit from the contribution
of manufacturing processes and business risk unique to that product
and distinct from the patented invention. In such instances, assuming
that all increases in anticipated profit margin for the product are
properly attributed to the infringed feature is precisely the kind
of unsupported speculation the courts should and do reject.
97
Moreover,
automatically awarding the entire residual anticipated profit to the
patentee as a “reasonable royalty” would do far more than
make the patentee whole, which is inconsistent with the goal of compensatory
patent damages and the statutory mandate that the patentee be compensated
only “for the use made of the invention by the infringer …
.”
98
95 Id. Or, in the words of the VirnetX court,
it “made too crude a generalization about a vastly more complicated
world.” VirnetX, slip op. at 38.
96 Id.
97 See ResQNet v. Lansa,
594 F.3d at 869 (“a reasonable royalty analysis requires a court
to hypothesize, not to speculate” (citing Fromson,
853 F.2d at 1574)); Grain Processing Corp. v. American
Maize-Products Co., 185
F.3d 1341, 1350, 51 U.S.P.Q.2d 1556 (Fed.
Cir. 1999) (“To prevent the hypothetical from lapsing into pure
speculation, this court requires sound economic proof of the nature
of the market and likely outcomes with infringement factored out of
the economic picture.”).
98 35 U.S.C. §284. SeeResQNet
v. Lansa, 594 F.3d at 869 (“Any evidence unrelated
to the claimed invention does not support compensation for infringement
but punishes beyond the reach of the statute.”); Pall
Corp. v. Micron Separations, Inc., 66 F.3d 1211, 1223, 36 U.S.P.Q.2d 1225 (Fed.
Cir. 1995) (“[T]he purpose of compensatory damages is not to
punish the infringer, but to make the patentee whole.”).
Second,
a mechanical calculation (and automatic award) of residual anticipated
profits also “fails to account for the unique relationship between
the parties.”
99
Simply awarding 100% of the
residual anticipated profits to the patentee ignores the parties'
relative bargaining strength, competitive positions, market conditions,
contributions to the accused product or process, and levels of risk
in implementing the technology, and all the other facts peculiar to
the parties.
99 Uniloc, 632 F.3d at
1313.
Third,
awarding 100% of the residual anticipated profits to the patentee “is
essentially arbitrary,” just as arbitrary as allocating 25%
of the profits from the infringing product to the patentee under a “rule
of thumb.”
100
Moreover, the purpose
of using the infringer's anticipated, instead of actual, profits in
the reasonable royalty analysis is to comport with the hypothetical
negotiation construct, which values the license as of a date before
infringement began and necessarily considers the risk each party is
taking in entering into the hypothetical license agreement. Stripped
of that construct, using the infringer's anticipated profit, with
its inherent risk allocation, makes no sense.
100 Id. at 1315 (rejecting 25% rule
of thumb).
In
short, Lucent v. Gateway’s “residual-profits”
version of the analytical method should be rejected, like the 25%
rule, because it “fails to tie a reasonable royalty base to
the facts of the case at issue”
101
and thus fails to “carefully tie
the proof of damages to the claimed invention's footprint in the market
place.”
102
It is difficult to
see how this approach could—or why it should—survive scrutiny.
101 Uniloc, 632 F.3d at
1315; id. at 1316 (“If the patentee fails to tie
the [damages] theory to the facts of the case, the testimony must
be excluded.”). Or, as the VirnetX court
put it, the patentee failed to establish a real world fit between
the particular situation and the premises underlying the Nash Bargaining
Solution. VirnetX, slip op. at 38.
102 ResQNet v. Lansa, 594
F.3d at 869.
The “Apportioned-Profits” Version
of the Analytical Approach
The other version
of the analytical approach suggested in the Lucent v. Gateway dictum “calculate[s]
damages based on the infringer's own internal profit projections for
the infringing item at the time the infringement began, and then apportion[s]
the projected profits between the patent owner and the infringer.”
103
Although this “apportioned-profits” version
of the analytical approach is subject to most of the same criticisms
as the “residual-profits” version, to the extent that
it suggests a rigorous apportionment to ensure that the royalty awarded
reflects the actual contribution made by the patented invention to
the accused products' commercial success, it at least acknowledges
an important principle of patent damages law.
104
The difficulty
lies in the apples and oranges nature of performing apportionment
on anticipated profits, apportionment having developed
before 1946 as applied to the infringer's actual profits
and often requiring reliance on evidence that post-dates the hypothetical
negotiation even though the profits being apportioned are those anticipated
at the time of the hypothetical negotiation and the apportionment
evidence is not properly considered under the Book of Wisdom. Accordingly,
as applied in practice, the apportionment that is performed under
this version of the analytical method, as in reasonable royalty analyses
generally, rarely identifies in any meaningful way the portion of
the anticipated profits attributable to the “patented feature.”
105
Similarly, although the pre-1946 “infringer's
profit” remedy required that the infringer's actual profits
be apportioned to reflect the value of the infringer's use of the
patented invention,
106
it
is in part because of the difficulties in performing that apportionment
that Congress adopted the reasonable royalty remedy.
107
Particularly in view of the
Supreme Court's determination that Congress intended “to eliminate
the recovery of profits,”
108
it is hard to justify reintroducing a
similarly afflicted analysis, albeit directed to anticipated rather
than actual profits, through a judicially-created “analytical
method.”
103 Lucent v. Gateway, 580
F.3d at 1324 (citation omitted); see Fresenius
v. Baxter, No. 3-cv-1431, ECF No. 446, slip op. at 10
(analytical method subtracts the infringer's normal profit from the
infringer's profits on the accused product “and awards some
portion of the remainder to the patent owner.” (quoting “Calculating
Intellectual Property Damages” (AICPA)). See also Oracle
v. Google, No. 3:10-cv-3561, ECF No. 352, slip op. at
1 (analytical method for determining a reasonable royalty calculates
damages based on infringer's internal profit projections for the infringing
item at the time infringement began and then apportions projected
profits between patentee and infringer).
104 See, e.g., VirnetX,
slip op. at 40 (noting with approval Nash Bargaining Solution being
based on “incremental profits earned by the infringer from the
sues of the patented features”); Uniloc,
632 F.3d at 1318 (“the patentee must in every case give evidence
tending to separate or apportion the defendant's profits and the patentee's
damages between the patented feature and the unpatented features,
and such evidence must be reliable and tangible, and not conjectural
or speculative” (quoting Garretson v. Clark,
111 U.S. at 121). Uniloc‘s reliance on Garretson recently
was called into question by another Federal Circuit panel in a non-precedential
opinion in Univ. of Pittsburgh v. Varian, 561
F. App'x at 934.
105 See, e.g., LaserDynamics,
694 F.3d at 69 (rejecting hypothetical negotiation apportionment that “appears
to have been plucked out of thin air based on vague qualitative notions
of the relative importance of the … technology”); Ultratec,
Inc. v. Sorenson Comm'ns, Inc., No. 13-cv-346, ECF No.
583, slip op. at 9 (W.D. Wis. Oct. 9, 2014) (rejecting hypothetical
negotiation apportionment that is mentioned only “in a single
footnote” and is not explained); Atlas IP, LLC v.
Medtronic, Inc., No. 13-cv-23309, ECF No. 237, slip op.
at 7-10 (S.D. Fla. Oct. 6, 2014) (rejecting “conclusory”
hypothetical negotiation apportionment analysis that “does not
withstand scrutiny”); Comcast IP Holdings I LLC v.
Sprint Comm'ns Co., No. 12-cv-205, 2014 BL 270018, ECF No. 324,
slip op. at 2 (D. Del. Sept. 29, 2014) (rejecting reliance on allegedly “apportioned
revenues and/or profits” as improper for ignoring relevant factors
that contribute to the value of the products and failing to even perform
a “numerical calculation”); Digital Reg of
Texas v. Adobe, ECF No. 632, slip op. at 9 (rejecting
inadequately explained apportionment of royalty base from 50% of profits
assumed under Nash Bargaining Solution to 30% of profits).
106 SeeDowagiac,
235 U.S. at 646 (“Insofar as the profits from the infringing
sales were attributable to the patented improvements, they belonged
to the [patentee], and in so far as they were due to other parts or
features they belonged to the defendants.”); Westinghouse
Elec. & Mfg. Co. v. Wagner Elec. & Mfg. Co., 225 U.S. 604, 614-15 (1912) (“if
plaintiff's patent only created a part of the profits, he is only
entitled to recover that part of the net gains” and must “give
evidence tending to separate or apportion the defendant's profits
and the patentee's damages between the patented feature and the unpatented
features”); Garretson v. Clark, 111 U.S.
at 121 (“When a patent is for an improvement, and not for an
entirely new machine or contrivance, the patentee must show in what
particulars his improvement has added to the usefulness of the machine
or contrivance. He must separate its results distinctly from those
of the other parts, so that the benefits derived from it may be distinctly
seen and appreciated.”).
107 See supra notes 11-14 and accompanying
text.
108 Aro, 377 U.S. at 505.
The “apportioned-profits”
version of the analytical method veers into direct conflict with Congressional
action when using the infringer's actual profits under
the Book of Wisdom as a proxy for the infringer's anticipated profits.
109
At that point, this version of the analytical
method becomes the identical remedy that Congress rejected
in 1946, the infringer's apportioned profits. Under no circumstances
should the courts resurrect this remedy that Congress has rejected.
Conclusion
The
infringer's profits have a role to play in reasonable royalty determinations.
As part of the hypothetical negotiation analysis, the infringer's
anticipated profits should act to cap the reasonable royalty, so as
to leave the suppositious licensee with a reasonable profit. Also
as part of the hypothetical negotiation, those infringer's anticipated
profits may be relevant to show the benefit to the infringer by its
use of the patented invention, but only if carefully apportioned to
identify the profits attributable to the patented invention, and not
other features. And as part of the hypothetical negotiation, the infringer's actual profits
may evidence the infringer's anticipated profits, but
only under circumstances identified under the Book of Wisdom. Moreover,
the Federal Circuit has left open the door to other ways to calculate
reasonable royalties, and some that have been proposed would consider
the infringer's apportioned actual profits.
110
110 See, e.g., “Structured Approach,”
supra note 43, at 639-41 (advocating considering the “share
of the profits attributable to the patented invention” but noting
the effect of “other successful, pending, and potential patent
claims on a technology in deciding how to allocate royalties for that
technology”).
But
the use of the infringer's anticipated profits in the so-called “analytical
method” mentioned in the Lucent v. Gateway dictum
finds no sound basis in the opinions from which that method purportedly
springs. The analytical method found its way into patent damages jurisprudence
through a misapplication of the notion that a hypothetical negotiation
reasonable royalty should be limited to that which would leave the
suppositious licensee with a reasonable profit based on its profit
expectations. Instead of applying that profit limitation as a cap,
the Tektronix court, the TWM court,
and courts that have followed in their wake, have applied it either
to define the royalty itself or, worse, as the baseline for a royalty
negotiation in which the patentee receives a royalty that would have
left the suppositious licensee with little or no profit expectation.
The analytical method has in practice allowed patentees to seek reasonable
royalty damages based on anticipated profits unencumbered by the burdens
of apportionment or rigorous analysis of the other Georgia-Pacific factors.
Both
versions of the Federal Circuit's analytical method—the “residual-profits”
and “apportioned-profits” versions—inappropriately
use the infringer's anticipated profits, not to cap the patentee's
recovery, but as a crude proxy to allow disgorgement of a portion
of the infringer's profits, a remedy that Congress rejected in 1946.
Where, under the Book of Wisdom, the patentee uses the infringer's
actual, instead of anticipated, profits, the apportioned-profits version
of the analytical method is exactly the remedy that Congress rejected.
Accordingly, either the Federal Circuit en banc or the Supreme Court
should strike down both versions of the Federal Circuit's analytical
method.
 
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