Sedona Conference Commentary on Patent Damages and Remedies

The Sedona Conference describes itself as "a nonprofit, 501(c)(3) research and educational institute dedicated to the advanced study of law and policy in the areas of antitrust law, complex litigation, and intellectual property rights."  The Sedona Conference Working Group Series describes its mission as the pursuit of "in-depth study of tipping point issues in the areas of antitrust law, complex litigation, and intellectual property rights, with the goal of producing high-quality, non-partisan commentary and guidance of immediate, practical benefit to the bench and bar."  Just recently I learned that the Sedona Conference Working Group on Patent Damages and Remedies (WG9) has published a public comment version of a document titled Commentary on Patent Damages and Remedies, available here, and is soliciting public comments on the Commentary through January 30, 2015.  Here is a link to information on submitting comments, and here is a link (behind a paywall, however) to a recent write-up on Bloomberg BNA's Patent, Copyright & Trademark Law Daily about an October 9 webinar on the Commentary.

The Commentary is quite interesting and covers a range of issues, including principles for calculating reasonable royalties, best practices for pretrial and trial procedure relating to damages issues, and the availability of injunctive relief.  There is much here that I think is very sensible, including the Working Group's suggestions relating to the availability of injunctive relief (pp. 53-54).  On this issue, the Working Group argues, among other things, that injunctive relief generally should not be available for the infringement of a FRAND-encumbered SEP (though, like Contreras and Gilbert, I would go further and say that injunctions generally should not be available for the infringement of SEPs even in the absence of a FRAND commitment; and perhaps the Working Group would agree too, because it also states that "[a] patent owner's practice of licensing the patent widely to whomever has requested a license presents a strong case for denial of the injunction").

Perhaps the most interesting part of the Commentary is the Working Group's recommended Principle II-1, which states that

The reasonable royalty in patent infringement matters should fairly compensate the patent holder for the actual use made by the infringer of the patented invention and should be determined by considering what fully informed and reasonable persons in the position of the patent owner (or owners throughout the period of infringement) and the infringer would agree to at the time of trial as a fair price for the use of the patented invention, from the time of first infringement through the time of trial, taking into account all relevant facts and circumstances occurring before or during that period" (emphasis added).  

The Working Group refers to this as the "retrospective model" (I would use the term "ex post" approach).  It also acknowledges that what it refers to as the "status quo" approach (and what I would refer to as the "ex ante" approach) is for the court to determine the royalty the parties would have agreed to as of a date just before the infringement began (ex ante)--though it also allows courts to consider ex post evidence (the so-called "book of wisdom") as an aid in determining the terms the parties would have agreed to ex ante.  The Working Group nevertheless argues that the book of wisdom principle is "amorphous" and unpredictable, and that 

the Retrospective Model is the most economically sound approach that both accomplishes the goals of the patent damages statute and also is consistent with the economic principles governing patent valuation. Taking all facts known through the time of trial into account eliminates the potential for unfairness in the prospective model without introducing the cherry-picking and uncertainty that the book of wisdom imported into that model (p.16).

It also recognizes, however, that "[m]oving the hypothetical negotiation . . . to a time at or near the time of trial has potential infirmities as well. Specifically, it could lead to a higher (and potentially unfair) royalty due to what are commonly known as 'lock in' effects" (id.)  To rectify this consequence, the Working Group recommends as Principle II-7 that

Where the technology claimed in the asserted patent is necessary to practice because (1) it is essential to a de facto standard or a standard adopted by a recognized standard setting organization (i.e., standard-essential); (2) a technically feasible non-infringing design around alternative is restricted or prohibited by government regulations or requirements; and/or (3) the technically feasible design around is cost-prohibitive, then the reasonable royalty should exclude any premium the patent may command solely resulting from the adoption of the standard or the governmental/commercial prohibitions on design modification. All standards adopted prior to trial may be considered.

In particular, 

where lock-in effects exist at the time of trial, the valuation of the patented technology must be performed at an earlier time, before the infringer was locked-in, so as to avoid the attachment of a premium to the value of the patent technology that results from the user’s lock-in. Accordingly, the Working Group determined that, for purposes of addressing lock-in and avoiding holdup effects, the patented technology to which the infringer is locked in generally should be valued in a manner that would exclude any premium the patent would command as a result of the adoption of the standard, i.e., any premium divorced from the technical merits of the technology. . . .

The parties should encourage their damages experts to take care to exclude from their reasonable royalty determination any hold-up effects that may result from a valuation performed after the relevant lock-in date. The reasonable royalty analysis should assign the reasonable royalty value prior to the relevant lock-in date. Upon the filing of a Daubert motion challenging the reasonable royalty methodology, the court should explicitly consider whether lock-in/hold-up effects were properly accounted for in the challenged methodology (pp. 26, 40).

My own view, as expressed in a forthcoming draft of a paper I am coauthoring with Norman Siebrasse that is tentatively titled A New Framework for Determining Reasonable Royalties in Patent Litigation, is that the Working Group is right to focus on ex post information as an indicium of patent value, but that the Working Group's proposed implementation of that insight needs some reworking.  As I see it, both the "status quo" and "retrospective" approaches as described by the Working Group suffer from a common defect:  the assumption that a hypothetical bargain taking place ex ante can be based only on information that is available ex ante.  Inspired in part by a paper published by Mario Mariniello titled Fair, Reasonable and Non-Discriminatory (FRAND) Terms: A Challenge for Competition Authorities, 7 J. Comp. L. & Econ. 523 (2011), however, Professor Siebrasse and I will argue that there is no good reason why this must be so, and that in general courts should calculate royalties based on a hypothetical negotiation taking place ex ante but with knowledge of all relevant facts that are known ex post.  Although this may sound less “real” than the ex ante or ex post approaches described above, it is important to recognize that all of these approaches are fictions—that’s what “hypothetical negotiation” means—and that courts should employ the fiction that best serves the goals of the patent system.  In our view, the goal in setting damages should be to award compensation that is commensurate with (though less than) the social value of the invention, and ex post information is better suited than is ex ante information to determine that value--you know more later than you did before about the invention's value.  That value may be higher or lower than what reasonable parties would have expected ex ante, a point the Working Group to its credit makes at p.16.  Moreover, as both we and the Working Group point out, even aside from the "book of wisdom" issue courts already use some ex post information when setting royalties, for example in determining the value of the royalty base for a running royalty, or when assuming that the hypothetical negotiation took place on the assumption that the patent was valid and infringed (a fact that is not established until the conclusion of trial).  Nevertheless, we think that posing the question of what bargain the parties would have struck ex post risks overcompensating patentees precisely because of hold-up or lock-in costs, which we understand to encompass any value the patentee is able to extract that is based on the cost of switching from an infringing to a noninfringing technology.  Those costs are not dependent on the patent in suit being standard-essential (though in the context of SEPs they are likely to be particularly high), and they bear no relation to the value of the invention as such. 

We therefore conclude that royalties should be calculated based on a hypothetical negotiation occurring ex ante--preferably before the infringer has incurred costs in reliance on its ability to use the patented technology--but with full knowledge of how valuable (or not) the patented technology would be, in comparison with alternatives, ex post.  (Interestingly, courts in Germany have sometimes expressed the reasonable royalty framework in similar terms, as involving the question of "what reasonable contracting parties would have agreed to, at the conclusion of a licensing agreement, if they had foreseen the future development and specifically the duration and amount of the use of the patent.")  In our forthcoming paper, we will expound upon this theme over a variety of contexts, including but not limited to SEPs, where our thesis indicates that a FRAND royalty should be equivalent to what the parties would have agreed to ex ante (before the standard is adopted) but with full knowledge of the value of the patent (ex post) as part of that standard.  This allows the court to avoid awarding damages based on the hold-up value, but at the same time recognizes that a portion of the patent's value may be complementary to the value of other patents within the standard (in other words, part of the value the patent owner should recover is due to the fact that the patent winds up being incorporated into a standard).

As stated, Professor Siebrasse and I are still working on our paper, but we hope to have a draft ready to post on ssrn before too long.  When it is ready, we probably will file a comment on the Working Group's Commentary that explains our views at greater length.