Yesterday the Federal Circuit issued an opinion (authored by Judge Taranto) in Aqua Shield v. Inter Pool Cover Team, available here. The patent in suit "claims enclosures designed to cover pools or create sun rooms," and the district court granted summary judgment for the patent owner on infringement of certain claims and validity. The district court then held a bench trial on damages. The court entered a permanent injunction but found that the plaintiff had not proven an entitlement to lost profits (an issue not challenged on appeal). As for reasonable royalties, the district court initially concluded that, although certain of the Georgia-Pacific factors weighed in favor of awarding a "higher" royalty rate, there was insufficient evidence of what the initial rate should be, and therefore awarded zero damages. On a post-trial motion, however, the court revised this particular conclusion. As described by the Federal Circuit (at p.5):
Noting 35 U.S.C. § 284’s “clear” instruction “that the Court ‘shall’ award damages ‘in no event less than a reasonable royalty,’” id. at *5, the court relied on evidence of IPC’s profits on past infringing sales as the foundation for a royalty calculation, id. at *3–5. The court found that IPC’s net profit on infringing sales had been five percent, amounting to $135,000. Id. at *5. Then, “[c]onsidering the benefits [of the patented invention], while still allowing Defendants a profit on infringing sales,” the court stated that, in a hypothetical negotiation occurring before infringement began, IPC would have been willing to pay a royalty of five percent of those net profits, but the court raised that figure to eight percent to reflect the Georgia-Pacific considerations that pointed toward a higher royalty. Id. The result was an award to Aqua Shield of $10,800 in damages.
The district court also concluded, however, that the infringement was not willful and therefore did not award enhanced damages.
On appeal, the court first set out the governing framework for appellate review of patent damages, as follows (pp. 5-6):
The amount of damages awarded to a patentee, when fixed by the district court, is a factual finding reviewed for clear error. SmithKline Diagnostics, Inc. v. Helena Labs. Corp., 926 F.2d 1161, 1164 (Fed. Cir. 1991). But the methodology underlying the district court’s damages computation is reviewed for abuse of discretion. Id. A district court abuses its discretion when it “ma[kes] a clear error of judgment in weighing relevant factors or clearly erroneous factual findings.” Genentech, Inc. v. Novo Nordisk A/S, 108 F.3d 1361, 1364 (Fed. Cir. 1997). In the damages context, therefore, we examine the methodology for consistency with the legal principles defining a reasonable royalty.
Second, the court stated that the hypothetical negotiation (or willing licensor-willing licensee) framework is determined based on what reasonable parties would have agreed to ex ante, and that ex post information is relevant only to the extent it is relevant in reconstructing the parties' ex ante expecations. (As some readers may be aware, Norman Siebrasse and I recently have taken issue with this framework, in this paper, so perhaps we will say something about this case in our next draft. The paper explains our critique of statements like some of the ones that follow below.) Here are the most relevant passages from Judge Taranto's opinion (pp. 6-8):
. . . The “value of what was taken”—the value of the use of the patented technology—measures the royalty. Dowagiac Mfg. Co. v. Minn. Moline Plow Co., 235 U.S. 641, 648 (1915). A traditional heuristic for assessing this market value is to posit a “hypothetical negotiation” between the patentee and adjudicated infringer and to “attempt to ascertain the royalty upon which the parties would have agreed had they successfully negotiated an agreement just before infringement began.” Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1324 (Fed. Cir. 2009). The inquiry, besides being hypothetical, involves approximation: “[t]he hypothetical negotiation tries, as best as possible, to recreate the ex ante licensing negotiation scenario and to describe the resulting agreement.” Id. at 1325.
. . . The district court correctly noted that the infringer’s actual profits earned during the period of infringement can be relevant to the inquiry, see Trans-World Mfg. Corp. v. Al Nyman & Sons, Inc., 750 F.2d 1552, 1568 (Fed. Cir. 1984), but it erred in the use it made of IPC’s profit figures. What an infringer’s profits actually turned out to have been during the infringement period may be relevant, but only in an indirect and limited way—as some evidence bearing on a directly relevant inquiry into anticipated profits. Thus, when the infringer is a profit-making enterprise, a “reasonable royalty is the amount that ‘a person, desiring to manufacture[, use, or] sell a patented article, as a business proposition, would be willing to pay as a royalty and yet be able to make[, use, or] sell the patented article, in the market, at a reasonable profit.’” Id. (bracketed changes in original; quoting earlier authority). In hypothetical-negotiation terms, the core economic question is what the infringer, in a hypothetical pre-infringement negotiation under hypothetical conditions, would have anticipated the profit-making potential of use of the patented technology to be, compared to using noninfringing alternatives. If a potential user of the patented technology would expect to earn X profits in the future without using the patented technology, and X + Y profits by using the patented technology, it would seem, as a prima facie matter, economically irrational to pay more than Y as a royalty—paying more would produce a loss compared to forgoing use of the patented technology. See Riles v. Shell Exploration & Prod. Co., 298 F.3d 1302, 1312 (Fed. Cir. 2002) (“The economic relationship between the patented method and non-infringing alternative methods, of necessity, would limit the hypothetical negotiation.”); Dowagiac, 235 U.S. at 648 (it is “permissible to show the value [of using the patented technology] 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” (emphasis added)); Suffolk Co. v. Hayden, 70 U.S. (3 Wall.) 315, 319–20 (1865).
. . . Another hypothetical assumption, bearing particularly on the anticipated-profits inquiry, abstracts away from the particular infringer’s degree of efficiency. An especially inefficient infringer—e.g., one operating with needlessly high costs, wasteful practices, or poor management—is not entitled to an especially low royalty rate simply because that is all it can afford to pay without forfeiting or unduly limiting its profit if it uses the patented technology rather than alternatives. Thus, the royalty the particular infringer could profitably pay by going about its business in its particular way does not set the market value that the hypothetical negotiation aims to identify.
Applying these standards here (pp. 10-11):
. . . two points are key. First, anticipated incremental profits under the hypothesized conditions are conceptually central to constraining the royalty negotiation, as recognized in Trans-World Mfg., 750 F.2d at 1568. Second, “[e]vidence of the infringer’s actual profits generally is admissible as probative of his anticipated profits.” Id.; see Interactive Pictures Corp. v. Infinite Pictures, Inc., 274 F.3d 1371, 1385 (Fed. Cir. 2001); see also Sinclair Ref. Co. v. Jenkins Petrol. Process Co., 289 U.S. 689, 698 (1933) (post-infringement evidence can be a relevant “book of wisdom”); Lucent, 580 F.3d at 1333.
Contrary to Aqua Shield’s broader contention, therefore, the district court did not err in considering IPC’s profits. But it did err in treating the profits IPC actually earned during the period of infringement as a royalty cap. That treatment incorrectly replaces the hypothetical inquiry into what the parties would have anticipated, looking forward when negotiating, with a backward looking inquiry into what turned out to have happened. See Interactive Pictures, 274 F.3d at 1385 (expectations govern, not actual results).
The district court’s analysis also incorrectly replaces the inquiry into the parties’ anticipation of what profits would be earned if a royalty (of amounts being negotiated) were to be paid with an inquiry into what profits were earned when IPC was charging prices without accounting for any royalty. Thus, the district court seems to have simply assumed that any royalty paid by IPC would have directly reduced its profits, dollar for dollar. But that would not be true, in general, if IPC could have raised its to account (fully or partly) for a royalty payment. The district court did not find, and IPC has not argued here, that IPC was selling in a perfectly competitive market in which it was forced to act as a pure price-taker. We have not been shown proof that this case is different from the typical one in which pricing might be adjusted to account for a royalty based on sales price. Indeed, IPC has not pointed to any evidence supporting the district court’s conclusion that a royalty should be a percentage of profits rather than sales revenues. . . .
Finally, on the issue of willfulness, the court stated that while the denial of a preliminary injunction is a factor that may weigh against such a finding, it is not necessarily dispositive, particularly where (as here) the denial (by a different district court) was based in part on questions over whether the court could assert personal jurisdiction over the defendant. While cautioning that it was not deciding the willfulness issue itself, the Federal Circuit stated that questions remained whether the defendant had implemented a noninfringing design-around after the summary judgment ruling; and that during the summary judgment proceedings the defendant had not presented a noninfringement defense against some of the claims in suit, and had not presented an element-by-element invalidity argument. The court vacated and remanded for consideration of whether the first and second Seagate prongs were satisfied, and stated that if the district court altered its findings on this issue it also should reconsider the plaintiff's request for attorneys' fees.