CHAPTER 5
`
`LOST PROFITS DAMAGES
`
`I.
`
`INTRODUCTION
`
`To promote the patent system’s incentives to innovate, patent law sets the goal of
`calibrating compensatory damages to replicate the market reward that would have been earned
`absent infringement. As Chapter 4 discusses, damages that undercompensate patentees
`according to that standard undermine the patent system’s incentives to innovate. Damages that
`overcompensate patentees can distort competition and decrease innovation.
`
`One way a patentee can innovate is to develop and commercialize the invention itself.
`For a patentee producing a patented product, the piimaiy importance of the patent is often the
`right it confers to exclude competitors from making and selling a competing product
`incorporating the patented technology. Often the most effective way to remedy infringement in
`this context is by awarding the patentee its profits on sales of the patented product that it lost due
`to the infringement.
`
`To accurately replicate the market reward that the patentee would have earned by
`practicing its invention, the lost profits damages calculation must account for competition that
`the patentee’s product would have faced if the infringer had sold a noninfringing alternative that
`did not incorporate the patented technology. Denying a patentee lost profits damages based on
`the availability of any acceptable alternative, as the seminal Pandm't case seems to suggest, can
`undercompensate the patent holder.1 But ignoring competition from alternatives that would have
`occurred in the absence of infringement, and awarding lost profits based on all infringing sales,
`can overcompensate it. Both outcomes can harm innovation and consumers.2
`
`Determining how the market would have rewarded the invention absent infringement can
`be done by assessing consumer preference for the patented technology and the degree of
`substitutability between the patented technology and noninfringing alternatives.3 That
`assessment can identify the number of consumers that would have purchased the patented
`product in the face of competition and the price they would have paid. The analysis and
`economic tools are similar to those used in antitrust cases to reconstruct a market and measure
`
`the effects of a proposed merger. The case law governing lost profits damages has moved toward
`this more economically grounded analysis since the Pandnit case in 1978. However, additional
`
`lPanduit Corp. V. Stahlin Bros. Fibre Works, Inc, 5 75 F.2d 1 152, 1156 (6th Cir. 1978) (requiring an
`absence of suitable noninfringing alternatives).
`
`2336 Chapter 4, Section III.
`
`3For a comprehensive discussion applying economic analysis to the calculation ofpatent damages, see
`ROGER D. BLAIR & THOMAS F. COTTER, INTELLECTUAL PROPERTY: ECONOMIC AND LEGAL DIMENSIONS
`
`OF RIGHTS AND REMEDIES 214—228 (2005); Roger D. Blair & Thomas F. Cotter, Rethinking Patent
`Damages, 10 TEX. INTELL. PROP. L]. 1 (2001).
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`improvements, including rejection of rigid rules such as the “entire market value rule” and the
`requirement for dual awards of lost profits and reasonable royalty damages, would increase the
`accuracy of damage awards. Such a result would better align patent damages law and competition
`policy, to the benefit of consumers.
`
`H.
`
`NONINFRINGING ALTERNATIVES IN A LOST PROFITS CALCULATION
`
`A.
`
`The Panduit Test
`
`To receive lost profits damages, a patentee must prove that, but for the infringement, it
`would have earned the lost profits it seeks, and that this loss was a foreseeable consequence of
`infringement. Infringing competition can reduce the patentee’s profits in several ways, including
`by diverting sales from the patentee’s product, eroding the patentee’s sales price, and causing the
`patentee to lose sales of related, non-patented products.4 The “Paaduit test” provides a
`commonly—used framework with which patentees can establish entitlement to test profits
`damages.
`It requires the patentee to prove:
`
`(1)
`
`(2)
`(3)
`
`(4)
`
`there was demand for the patented product in the relevant market during
`the period at issue;
`there were no suitable noninfringing alternatives to the patented product;
`the patentee had the manufacturing and marketing capacity to meet the
`demand claimed; and
`the amount of profit it would have made.5
`
`Pandaz‘t appears to create an allaormnothing test: in the absence of noninfringing
`alternatives, and assuming the patentee satisfies the other criteria, the patentee receives lost
`profits on ali the infringer’s sales. When noninfringing alternatives are available, the patentee
`receives no lost profits.6 Later cases, however, have adopted a more flexible approach that
`allows a patentee to recover lost profits on some, but not all, of the infringer’s sales. For
`instance, in State Industries v. Mar-Flo Industries, the court awarded lost profits damages on the
`portion of infringing sales that corresponded to the patentee’s market share.7 The analysis
`
`‘See Rite—Bite Corp. v. Kelly Co, 56 F.3d 1538, 1546 (Fed. Cir. 1995); TWM Mfg. Co. v. Dura Corp,
`789 F.2d 895, 902 (Fed. Cir. 1986) (price erosion).
`
`SPandutl Corp, 575 F.2d at 1156.
`
`61d.
`
`7883» F.2d l573, l578 (Fed. Cir. 1989); see also Micro Motion, Inc. v. Kane Steel Co.. 894 F.2d 1318
`(Fed. Cir. 1990).
`
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`assumed that the remainder of the infringer’s customers likely would have chosen alternative
`products. The court described this market share calculation as an alternative to the Pandas? test.S
`
`Panelists and commentators have criticized the Panduit test because the “factors [are]
`
`. necessary conditions” for a lost profits award, when in fact “you can have iost
`.
`stated as .
`profits, even if one or more of them aren’t satisfied.”9 One commentator argues that courts have
`at times imposed unrealistic evidentiaiy burdens on patentees to establish the precise extent of
`their lost profits, thereby relegating them to reasonable royalty recoveries that are not designed to
`remedy their losses.10 Panelists proposed an approach for calculating lost profits focused on
`“[i]dentify[ing] the defendant’s next best alternative to infringing” and then determining “the
`market outcome in the ‘but for’ world where it pursued [that] alternative instead of infringing.
`Further development in the case law along these lines, toward an economically grounded
`calculation of lost profits and away from rigid rules like the Panduit test, would increasc the
`accuracy of lost profit damage awards and help fully compensate patentees. Moreover, courts
`should recognize that a lost profits determination is “not an exact science”12 and permit plaintiffs
`to “approximate, if necessary, the amount to which. the patent owner is entitled.”13
`
`”11
`
`in assessing how the market would have rewarded the
`Recommendation.
`invention absent infringement, courts should allow a patentee flexibility in
`creating the “but for” world to address different losses and avoid
`
`8Bic Leisure Prods, Inc. V. Windsurfing lnt’l, Inc, 1 F.3d 1214, 1219 (Fed. Cir. 1993) (allowing “a
`patentee to recover lost profits, despite the presence of acceptable, noninfringing substitutes, because it
`nevertheless can prove with reasonable probability sales it would have made ‘but for’ the infringement”);
`see also Grain Processing Corp. v. American Maize—Prods, 185 F.3d 1341, 1349-50 (Fed. Cir. 1999)
`(recognizing that but for infringement, the defendant would have participated in the market by using an
`available, noninfringing alternative); In re Mahurkar Double Lumen Hemodialysis Catheter Patent Litig,
`831 F. Supp. 1354, 1390 (N .D. 111. 1993) (Easterbrook, J., sitting by designation) (recognizing that absent
`infringement, the patentee may have made additional sales at a higher prices).
`
`9Leonard at 48 (2/ 1 1/09); Comment of John W. Sehlichcr at 53 (5! 15.109) (“efforts to apply [the Pancfuz’t
`test] have largely been unfruitful”).
`
`10l\/Iark A. Lemley, Distingttis/ting Lost Profits from Reasonable Royalties, 51 WM. & MARY L. REV. 655,
`657—61 (2009). The same article argues that courts have inflated reasonable royalty damages in. an
`attempt to compensate patentees for denied lost profit claims. Id. at 661—69. Chapter 6 discusses the
`detrimental effects of inflating reasonabie royalty damages for this reason.
`
`11Comment of Greg Leonard at 78 (3/9/09); Blair & Cotter supra, note 3 at 15; Vincent E. O’Brien,
`Economics and Key Patent Damages Cases. 9 U. BALT. INTELL. PROP. LJ. 1, 6 (2000); see also Levko at
`59 (2/11/09) (noting that the “but for” world should broadly look at market definition).
`
`12King instrument Corp. v. Otari Corp, 767 F.2d 853, 863 (Fed. Cir. 1985).
`
`13Del Mar Avionics, lnc. V. Quinton Instrument Co., 836 F.2d 1320, 1327 (Fed. Cir. 1987).
`
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`undercornpensation. Patentees should not be denied an opportunity to establish
`lost profits through application of rigid rules that do not reflect sound economic
`principles or imposition of evidentiary requirements beyond what is required for
`the court to make a reasonable approximation of the patentee’s loss.
`
`An economically grounded approach to calculating lost profits damages focuses on the
`market for the patentee’s product. It generally requires considering the sales and prices that the
`patentee actually made and comparing them to the sales it would have made in the “but for”
`worid where the infringer sold a noninfringing alternative, if one is available. That comparison
`involves quantifying the number of sales the patentee lost due to infringement and estimating the
`extent of any price erosion.14 This analysis must consider the extent of consumer preferences for
`the patented feature over alternatives, and not simply treat alternatives as failing on either side Of
`a bright line dividing the acceptahie from the unacceptable.
`instead, the analysis recognizes that
`the “degree of substitutahility” between the patented product and the noninfringing substitute
`will affect the extent of the loss caused by infringement, as opposed to competition generally.15
`
`At one end of the spectrum, consumers freely substitute alternatives for the patented
`product. The infringer could have made neariy as many sales by offering the alternative.
`in such
`a case, the patentee lost few sales due to infringement and should receive little lost profits
`damages.16 The patentee’s recovery is limited because its invention contributes relatively iittie
`value over alternatives, and the damages should reflect this fact. At the other end of the
`spectrum, consumers strongly prefer the patented product over alternatives and will pay higher
`
`l4See, e. g, Gregory J. Werden, Luke M. Froeb & Lucian Wayne Beavers, Economic Analysis Lost Profits
`from Parent Inflingernent With and Without Noninfringing Substitutes, 27 AIPLA QJ. 305, 307—08
`(1999); Gregory K. Leonard, Appiying Merger Simuiation Techniques to Estimate Lost Profit Damages
`in InreZZecraa! Property Litigation, in ECONOMIC APPROACHES TO INTELLECTUAL PROPERTY, POLICY,
`LITIGATION, AND MANAGEMENT 112—13 (Gregmy K. Leonard & Lauren J. Stiroh eds, 2005). The
`analysis should also recognize that at lower prices, the patentee may sell more products, which wiil affect
`the amount Ofprofits lost by infringement. Gregory J. Werden, larcian Wayne Beavers & Luke M.
`Frocb, Quentin: Accretion: Mirror Image ofPrice Erosion from Patent Infringement, 81 J‘. PAT. 82;
`TRADEMARK OFF. SOC’Y 479 (1999); see afso Comment OfJOhn W. Schlicher at 54 (5/1/09).
`
`15In re M’anurftar Doubie Lumen Hemociiaiysis Catheter Patent Litig, 831 F. Supp. at 1390
`(“Competition is not an all-or-nothing proposition. There are degrees of substituability.”); Werden et a1,
`supra note 14, at 310 (noting that “[i]n some sense, there are always substitutes for the patented
`product”).
`
`J6See Grain Processing Corp. V. American Maize~Pmds C0,, 893 F. Supp. 1386, 1392 (NI). ind. 1995)
`(Easterhrook, l, sitting by designation), afl’d in part, vacated in part, 108 F.3d 1392 (Fed. Cir. 1997)
`(awarding no lost profits damages due to availability of alternative); but see Jerry A. Hausrnan, Gregory
`K. Leonard & J. Gregory Sidak, Patent Damages and Real Options: How Judicia! Characterization of
`Noninfiinging Alternatives Reduces Incentives to Innovate, 22 BERKELEY TECH. LJ. 825, 852—53 (2007)
`(arguing that “the district court’s conclusion in Grain Processing that no lost profits existed if the
`infringer were assumed to have adopted the noninfringing technoiogy is at odds with standard economic
`theory”).
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`prices for it. In the world without infringement, the patentee likely would have made most of the
`infringer’s sales at a higher price, earning a large return on its invention. It should receive
`substantial lost profits damages adequate to compensate for the market reward it would have
`earned absent infringement. In both cases, the remedy reflects the value of the invention,
`providing proper incentives for invention and innovation. Many patented products and their
`alternatives fall between these two extremes, but these also are entitled to lost profits damages
`when proven.17
`
`Economic analysis of the type used in antitrust merger review can help determine where
`alternatives fall along this spectrum, the number of sales lost to the infringing product, and the
`price erosion caused by infringement.18 Measuring the cross-elasticity of demand between an
`infringing product and noninfringing alternatives can determine their “degrees of
`subs"ti.tutability.”19 Economists have explained that “[slimulating damages from patent
`infringement is quite similar to simulating the effects of a merger. Rather than extrapolating
`from the lower-price, pie—merger equilibrium to the higher-price, post—merger equilibrium, one
`extrapolates from the iower~p1ice, with infringement equilibrium to the higherwprice, but~for~
`infringement equilibrium.”20
`
`B.
`
`The Entire Market Value Rule
`
`The law of lost profits damages recognizes that a patented invention may be only one
`component of a complex product. In that case, not all of the infiinger’s profit, or the patentee’s
`lost profits, is necessarily attributable to the patented invention. The case law traditionally
`addresses this issue by “apportioning” the potential damages according to the value the invention,
`such as a mop head, contributes to the product, such as a mop.21 Modern case law applies the
`“entire market value rule” to determine when to award lost profits damages based on the entire
`
`175363 O’Brien, supra note 1 1, at 6. Cf, Lcmley, supra note 10, at 6751-72 (arguing that a patentee’s
`difficulty in proving precise amount of lost profits damages, as opposed to entitlement to them, should
`not disqualify it from receiving them).
`
`18Blair & Cotter, supm note 3, at 15 —1.6 (“modern economic analysis does provide some techniques for
`estimating losses” based on construction ofa market absent infringement); see also Marion B. Stewart,
`Calculating Economic Damages in, Ineliectuai Property Disputes: The Role OfMarkel' Definition, 77 .l.
`PAT. & TRADEMARK OFF. SOC’Y 321 (1995).
`
`19Blair & Cotter, supra note 3, at 13—14, 11.34 (explaining relationship of cross—elasticity of demand to lost
`profits).
`
`20VVerdcn et at, supra note 14, at 303—08.
`
`21Seymour V. McCormick, 57 US. 480, 489—91, (1853) (explaining that damages based on an entire
`machine when the patent covers only a component could subject the infringer to duplicative and
`excessive damages); see also Garretson V. Clark, 11 1 US. 120, 121 (1884) {requiring apportionment of
`damages from sales of a mop based on infringement of patent covering improved mop head).
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`value of the patented product. The entire market value rule applies when (1) the patented feature
`is “the basis for customer demand”22 of the infringing product and (2) the patented and
`unpatented components together “constitute a functional unit.”23 For instance, in Golden Bloom,
`Inc. 1/. Robert H. Petenson Can, the Federai Circuit allowed lost profits damages based on the
`entire market value of an artificial fireplace where only the gas burner was patented. The court
`upheld a finding that the burner, logs and grate worked together as a fimctional unit and that the
`ember burner was the basis for customer demand.24
`
`The entire market value rule is not needed in an economic assessment of lost profits.
`indeed, it distracts fact-finders from a carefiil reconstruction of a market lacking infringement.
`Courts should reject it. The rule’s focus on whether a feature is the “basis for customer demand,”
`and allowing only a “yes” or “no” answer to that question, prevents courts and juries from giving
`adequate consideration to the “degrees of substitutability” that may exist with respect to
`noninfringing alternatives.25 In doing so, it inhibits an appreciation of the differences among
`consumers and their preferences for different alternatives. The “functional unit” prong of the
`
`
`
`22Stare Indira, Inc, 883 F.2d at 1580. This “basis of customer demand” standard as sometimes applied is
`arguably more lenient than statements of earlier cases requiring that “the entire value of the whole
`machine, as a marketable article, is properly and legally attributable to the patented feature” for damages
`to be based on the whole product. Garretson, 1 11 US. at 121, (quoting Garretson v. Clark, 10 F. Gas. 40,
`44 (C.C.N.Y. 1878). Compare State Indus, Inc, 883 F.2d at 11580 (allowing lost profits damages based
`on entire water heater where invention related to foam insulation) with Marconi. Wireless Tele. Co. v.
`United States, .99 Ct. Cl. 1., 21 (Ct. Cl. 1942). afl’d in part, vacated in part, 320 US. l (l943) (holding
`that patentee can recover damages based on an entire product if patented feature “was of such paramount
`importance that it substantially created the value of the component parts”).
`
`23Rite~Hite Corp, 56 F.3d at 1550 (lost profits damages may be based on the entire market value of a
`product only where “the patented and unpa’tented components were analogous to a single functioning
`unit” and may not be extended to include unpatented items “that have essentially no functional
`relationship to the patented invention and that may have been sold with an infringing device only as a
`matter of convenience or business advantage”).
`
`2"’438 F.3d 1354, l3?1-?2 (Fed. Cir. 2006). Sec 625.90 Tec Air, Inc. v. Denso Mfg. Michigan, Inc., l92
`F.3d 1353, 1361 (Fed. Cir. 1999) (damages based on entire assembly where infringing fans were sold
`with noninfringing radiator and condenser).
`
`25The “basis for consumer demand” standard is not a good proxy for those instances in which no
`alternatives for the patented invention exist such that the patentee would have made all infringing sales.
`The standard has been liberally applied in. some cases, and it fails to focus on the operative economic
`question of noninfringing competition. See Golden Bloom, Inc., 438 F.3d at 1371 (allowing damages
`based on entire artificial, fireplace when only gas burner was patented, without examining noninfringing
`competition in artificial fireplace market); Tee Air, Inc., 192 F.3d at 1361 (damages based on entire
`assembly where infringing fans were sold with noninfringing radiator and condenser because consumer
`demand was based on performance of entire assembly).
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`rule makes the determination of damages hinge on a distinction that is irrelevant to
`reconstruction of a market lacking infringement.26
`
`The all or nothing aspect of the entire market value rule detracts from the ability of patent
`damages to provide compensation to patentees that reflects the value of their inventions, and
`thereby align with competition policy. A more nuanced economic analysis can help identify the
`extent to which infringement causes a patentee to lose profits whether the patent at issue claims
`the entire infringing product or one component of that product. When consumers View a
`patented component as a vaiuable feature of a larger product, they are less likeiy to be satisfied
`with similar products containing noninfringing alternative components. The more valuable the
`patented feature is to consumers, the larger the portion of the infringer’s sales that can be
`attributed to infringement. However, when consumers View a patented component as a minor
`feature that they would forgo at higher prices or substitute with noninfringing alternatives,
`infringement causes the patentee to lose fewer sales.27
`
`Under this economic analysis, the infringer’s sales are effectively “apportioned”
`according to the vaiue of the invention. This approach provides a more direct and accurate
`measure of a patentee’s harm from infringement when one component of a product is patented
`than does an attempt to measure that component’s relative contribution to a product or to appiy
`the entire market value rule.
`
`Recommendation. Courts should reject the entire market value rule as a basis for
`awarding a patentee lost profits damages based on all infringing sales, and instead require
`proofof the degree of consumer preference for the patented invention over alternatives.
`
`C.
`
`Dual Awards of Lost Profits and Reasonable Royaities
`
`When courts have awarded lost profits damages based on, a portion of the infringing sales,
`they also have sometimes awarded reasonable royalty damages on the remaining portion of
`infringing sales.28 Those cases refer to Section 284 of the Patent Act in reasoning that a patentee
`
`26See Juicy Whip, Inc. v. Orange Bang, Ind, 382 F.3d 1367, 1371~73 (Fed. Cir. 2004) (remanding for
`consideration of whether patentee was entitied to damages based on sales of unpatented syrup and
`because syrup and patented juice dispenser functioned together “to produce the visual appearance that
`was central to Juicy Whip’s ”405 patent”). If a patentee can prove that it would have made sales of an
`unpatented product along with a patented product but for the infringement, examining whether they
`function as a unit may be useful in determining whether lost sales of the unpatented product were
`“foreseeable” and compensable. See Blair & Cotter, supra note 3, at 89 (proposing this limited use of the
`functional unit test); Rire~Hite Corp, 56 F.3d at 1546 (requiring that lost profits be foreseeable to be
`compensable).
`
`27568 Blair & Cotter, supra note 3, at 17, 26-28; Leonard Comment at 8-9 (3/9/09).
`
`28State Indus, Inc, 883 F.2d at 1580; Rite-Hire Corp, 56 F.3d at 1554—55 (awarding lost profits damages
`on all but 502 sales and awarding reasonable royalties on those).
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`is entitied to “no less than a reasonable royalty” on all of an infringer’s sales, even when it has
`received its profits lost due to infringement.29 In many instances, dual awards of test profits and
`reasonable royalty damages are inappropriate and courts should not award them.38
`
`When a patentee receives lost profits damages on lost sales amounting to only a portion
`of the infringer’s sales, the award recognizes that, but for infringement, the infringer would have
`sold an alternative to the patented invention. Putting the patentee in the position it would have
`been but for the infringement does not require compensating it for sales the infringer would have
`made of noninfringing alternatives. Awarding the patentee reasonable royalty damages on those
`sales in addition to lost profits overcompensates it compared to the market reward for the
`invention, because it ignores competition that the patented invention faced from noninfringing
`alternatives.31 Awarding lost profits damages based on a portion of the infringer’s sales can fully
`compensate the patentee for infringement, as required by Section 284.
`
`Recommendation. Courts should reject dual awards of lost profits and reasonable royalty
`damages when competition from alternatives would have prevented the patentee from
`making all the infringer’s sales in a world but for infringement.
`
`III.
`
`CONCLUSION
`
`The guiding principle in the calculation of lost profits damages is the construction of the
`hypothetical, market but for infringement.
`In that market, the patented invention may sometimes
`compete with noninfringing alternatives. Accurately calculating damages in the face of that
`competition requires an examination of consumer preferences for the patented invention over
`alternatives. Economic tools, including those frequently used in antitrust analysis. can support
`that calculation.
`
`The case law has evolved to recognize the importance of “the realities of the market.”32
`But further flexibility in the legal rules that apply to lost profits damages would allow a more
`economically grounded calculation, leading to more accurate awards and full compensation of
`
`29Rite—12579 Corp, 56 F.3d at 1554.
`
`30One situation in which dual awards might be appropriate is when markets for the patented
`product are separated by geography or type of use. A patentee may seek to earn royalties in one
`market (making reasonable royalty damages appropriate) but seil its invention exclusively in
`another (making lost profits appropriate). O‘Brien, supra note 11, at 21 n74.
`
`“See O’Brien, supra note ll, at 21-22; Comment of John W. Schlicher at 54 (5/11’09) (when law insists
`that patentcc recover damages on every infringing unit sold, the patentec is better off financially than it
`would have been absent infringement).
`
`3BSmithKline Diagnostics, Inc. v. Helena Lab. Corp, 926 F.2d l 161, l l66 (Fed. Cir. 1991) (considering
`whether “others would likely have captured sales made by the infiinger, despite a difference in the
`products”).
`
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`patentees. Patentees that have proven entitlement to lost profits damages should not be denied
`that compensation and limited to reasonable royalties based on overly—rigorous requirements to
`show the precise amount of damages.
`
`To achieve accurate awards, calculation of lost profits damages must also take account of
`competition the patented product would have faced but for infringement. Courts should reject as
`not based on sound economics the entire market value rule and dual awards of lost profits and
`reasonable royalty damages in most situations. Additional focus on creating the world but for
`infringement, including a filll appreciation of the role of noninfringing alternatives in that world,
`will help compensate patentees through damages as the market would have done, avoiding the
`under and overcompensation that can harm innovation, competition and consumers.
`
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`THE HYPOTHE'I‘ICAL NEGO'I‘IA'I‘ION IN REASONABLE ROYALTY DAMAGES
`
`CHAPTER 6
`
`INTRODUCTION ................................................... 160
`
`II.
`
`RECENT CONTROVERSIES SURROUNDING REASONABLE
`
`ROYALTY DAMAGE AWARDS ....................................... 161
`
`A.
`
`B.
`
`C.
`
`Support for Damages Reform .................................... 161
`
`Opposition to Damages Reform . ................................. 163
`
`The Need to Review Damages Law ................................ 164
`
`III.
`
`OVERVIEW OF REASONABLE ROYALTY DAMAGES LA‘W ............ 165
`
`IV.
`
`CONCERNS WITH THE HYPOTHETICAL
`
`NEGOTIATION FRAMEWORK ...................................... 167
`
`A.
`
`B.
`
`The Counterfaetual Nature of the Hypothetical Negotiation ........... 170
`
`Deterrents t0 Infringement . ..................................... 173
`
`CONCLUSION AND RECOMMENDATION . ........................... 175
`
`159
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`THE HYPOTHE'I‘ICAL NEGO'I‘IA'I‘ION IN REASONABLE ROYALTY DAMAGES
`
`CHAPTER 6
`
`I.
`
`INTRODUCTION
`
`Much of the controversy in the patent community concerning damage awards has focused
`on whether the law governing reasonable royalty damages appropriately compensates patentees.
`Different perspectives on this question have fueled a debate on the wisdom of legislative changes
`to reasonable royalty damages law as part of a broader patent law reform effort.1 Companies fall
`on opposite sides of this question depending on a number of factors, including whether they View
`themselves as more likely defendants or plaintiffs in patent litigation, whether they use patents
`primarily defensively or offensively, how likely it is that a patent in their industry might confer
`market power, and how many patents typically cover a single product.
`
`Different sides of the debate have at times looked to median damage awards as evidence
`of both the presence and the absence of a problem. But medians cannot answer the question of
`whether patent damages iaw appropriately compensates patentees. They supply no information
`about the accuracy of individual awards or the effect of very large awards that arguably motivate
`some litigation. That said, several factors suggest that a careful study of the economic
`underpinnings of reasonable royalty damages law would be beneficial. On the one hand, full
`compensation is important to incentivize invention and support licensing in a growing open
`technology paradigm.2 On the other hand, dramatic increases in litigation in the information
`technology (lT) industries and the rise in business models that use patents only to extract rents, if
`driven by awards that overcompensate patentees, could deter innovation and disrupt competition
`in technology markets.3
`
`As discussed in Chapter 4, damages law appropriately compensates patentees for
`infringement when it aligns damage awards with the economic value of the invention by
`replicating the market reward. When a patentee cannot or chooses not to prove lost profits or
`other direct harm, the market reward is the royalty to which a willing licensor and willing
`licensee would agree in a hypothetical negotiation. But courts sometimes reject, either implicitly
`or explicitly, a limitation based on the maximum amount a willing licensee would pay. In doing
`so, they often seem motivated by concerns about compensating patentees for unproven direct
`harm and deterring infringement. Those concerns are better addressed through other areas of
`remedies law, including lost profits damages, enhanced damages and injunctions. Allowing
`those concerns to distort the reasonable royalty damages calculation risks overcompensating
`patentees in litigation as compared to the market and creating problems such as higher prices,
`increased patent speculation, and decreased innovation.
`
`18. REP. N0. ”148, at 3 (2009).
`
`2596 Chapter 1.
`
`3See Chapter 2.
`
`160
`
`SKH_ITCOGOZ872
`RX-0870.166
`
`

`

`This Chapter and Chapter 7 seek to derive an economically grounded approach to
`calculating reasonable royalty damages and to compare that approach to the rules developed
`through case law. Ensuring that the iegal rules reflect an understanding of the economics
`underlying the market in which technology competes will heip align a patentee’s compensation
`with the economic value of the patented invention, and align patent law with competition policy.
`
`IL
`
`RECENT CONTROVERSIES SURROUNDING REASONABLE ROYALTY
`
`DAMAGE AWARDS
`
`A.
`
`Support for Damages Reform
`
`Those who compiain about the current state of damages law come mainly from the IT
`industries. They argue that patent value has become increasingly divorced from the economic
`value of the underlying technology in recent years because of excessive damages awards.4 From
`2002—2009, there were at least eleven damage awards over $100 million and one that was over $1
`billion, representing a marked increase in landmark damage awards compared to 20 years ago.5
`White some very large awards have been overturned,6 “outlier” cases still raise concerns because
`they inform and influence the licensing and settlement negotiations that resolve the vast majority
`
`4566, 8g, Yen at 47 ( 12/5/08) ( “Increasingly, activity in the marketplace is driven not by increased
`innovation but by efforts to exploit imbalances in a patent system that overvalues patents, particularly
`weak ones, and thereby actually suppresses marketplace innovation”); CCIA Comment at 6-7 (2/5/09);
`Doyle at 143 (5/5/09) (the current damages system “encourages what I wouid consider opportunistic
`litigation that has little relation to the value of a patent, its patent—worthiness, its validity, let alone
`whether or not it’s infringed”).
`
`5Paui Janicke, Patent Damages, Patent Verdicts from 1—1-05 to 1‘6—09, presented at FTC Hearing: The
`Evolving 1P Marketplace (Feb. 1 1, 2009), available at
`
`htt
`:X/ftc.crov/hc/worksho s/i marke lace/fab}1/docs/’anioke-medianverdits. df; Janickc at 9 (2/1 1/09)
`(explaining that these numbers are “only what the jury foreman announced” and do not reflect
`enhancements (cg, for wilifutness or interest) or subsequent judicial actions reducing or vacating the
`award). See (1230 Levko at 21 (2/11/09) (reporting that there had been “something like 22 cases” with
`awards over $100 miilion (in 20