Federal Circuit Vacates Damages Award in Ericsson v. D-Link

Here's the link to the opinion, which came out this morning.  Jason Rantanen has a good write-up on the case here, and I blogged about the oral argument in the case this past June here.  For now, I'll focus exclusively on the damages issues, discussion of which begins at page 36 of Judge O'Malley's opinion. (Judge Hughes joined in the opinion in its entirety; Judge Taranto would have reversed the finding of infringement of one of the patents in suit, but concurred in the remainder.)

1.  D-Link objected to Ericsson's expert's use of allegedly comparable licenses for which the royalty base is the value of a licensee's end product, not the value of the WiFi chips that practice the patents in suit, on the ground that calculating a royalty using the licensee's end product as a base contravenes the entire market value rule (EMVR).  The court affirms the district court's conclusion that the licenses were properly admissible.  I'll quote Judge O'Malley's opinion here at some length because I think she really hits the nail on the head--the gist being that if real-world parties use the value of the end product as a base in negotiating real-world licenses, those licenses should be relevant evidence, and that the main thing the EMVR is intended to avoid is having the jury be unduly influenced simply by hearing about a large base.  Here's what she says:

While a number of our cases have referred to the concept of an entire market value “rule,” the legal standard actually has two parts, which are different in character. There is one substantive legal rule, and there is a separate evidentiary principle; the latter assisting in reliably implementing the rule when—in a case involving a per-unit royalty—the jury is asked to choose a royalty base as the starting point for calculating a reasonable royalty award.

As we explained recently in VirnetX, Inc. v. Cisco Systems, Inc., 767 F.3d 1308 (Fed. Cir. 2014), where multicomponent products are involved, the governing rule is that the ultimate combination of royalty base and royalty rate must reflect the value attributable to the infringing features of the product, and no more. 767 F.3d at 1326 (citing Garretson v. Clark, 111 U.S. 120, 121 (1884)). As a substantive matter, it is the “value of what was taken” that measures a “reasonable royalty” under 35 U.S.C. § 284. Dowagiac Mfg. Co. v. Minn. Moline Plow Co., 235 U.S. 641, 648 (1915). What is taken from the owner of a utility patent (for purposes of assessing damages under § 284) is only the patented technology, and so the value to be measured is only the value of the infringing features of an accused product.

When the accused infringing products have both patented and unpatented features, measuring this value requires a determination of the value added by such features. Indeed, apportionment is required even for nonroyalty forms of damages: a jury must ultimately “apportion the defendant’s profits and the patentee’s damages between the patented feature and the unpatented features” using “reliable and tangible” evidence. Garretson, 111 U.S. at 121. Logically, an economist could do this in various ways—by careful selection of the royalty base to reflect the value added by the patented feature, where that differentiation is possible; by adjustment of theroyalty rate so as to discount the value of a product’s nonpatented features; or by a combination thereof. The essential requirement is that the ultimate reasonable royalty award must be based on the incremental value that the patented invention adds to the end product. 

Our cases have added to that governing legal rule an important evidentiary principle. The point of the evidentiary principle is to help our jury system reliably implement the substantive statutory requirement of apportionment of royalty damages to the invention’s value. The principle, applicable specifically to the choice of a royalty base, is that, where a multi-component product is at issue and the patented feature is not the item which imbues the combination of the other features with value, care must be taken to avoid misleading the jury by placing undue emphasis on the value of the entire product. It is not that an appropriately apportioned royalty award could never be fashioned by starting with the entire market value of a multi-component product—by, for instance, dramatically reducing the royalty rate to be applied in those cases—it is that reliance on the entire market value might mislead the jury, who may be less equipped to understand the extent to which the royalty rate would need to do the work in such instances. See LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 67, 68 (Fed. Cir. 2012) (barring the use of too high a royalty base—even if mathematically offset by a “‘low enough royalty rate’”—because such a base “carries a considerable risk” of misleading a jury into overcompensating, stating that such a base “‘cannot help but skew the damages horizon for the jury’” and “make a patentee’s proffered damages amount appear modest by comparison” (quoting Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292, 1320 (Fed. Cir. 2011))). Thus, where the entire value of a machine as a marketable article is “properly and legally attributable to the patented feature,” the damages owed to the patentee may be calculated byreference to that value. Id. Where it is not, however, courts must insist on a more realistic starting point for the royalty calculations by juries—often, the smallest salable unit and, at times, even less. VirnetX, 767 F.3d at 1327–28.

We apply these concepts to a challenge to expert testimony regarding licenses in which royalties were set by reference to the value of an end product. We conclude that the expert testimony about which D-Link complains violated neither the rule from Garretson regarding apportionment, nor the evidentiary principle demanding an appropriate balance between the probative value of admittedly relevant damages evidence and the prejudicial impact of such evidence caused by the potential to mislead the jury into awarding an unduly high royalty. We find, accordingly, that the district court did not err by failing to exercise its discretion under Federal Rule of Evidence 403 to exclude the license testimony at issue here. Uniloc, 632 F.3d at 1320; see LaserDynamics, 694 F.3d at 77–78 (finding that the district court abused its discretion by failing to exclude a license under Federal Rule of Evidence 403).

This court has recognized that licenses may be presented to the jury to help the jury decide an appropriate royalty award. See, e.g., Monsanto Co. v. McFarling, 488 F.3d 973, 978 (Fed. Cir. 2007) (“An established royalty is usually the best measure of a ‘reasonable’ royalty for a given use of an invention . . . .”); Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y. 1970) (finding that “royalties received by the patentee for the licensing of the patent in suit” is a relevant factor for the jury to consider). Prior licenses, however, are almost never perfectly analogous to the infringement action. VirnetX, 767 F.3d at 1330. For example, allegedly comparable licenses may cover more patents than are at issue in the action, include cross-licensing terms, cover foreign intellectual property rights, or, as here, be calculated assome percentage of the value of a multi-component product. Testimony relying on licenses must account for such distinguishing facts when invoking them to value the patented invention. Recognizing that constraint, however, the fact that a license is not perfectly analogous generally goes to the weight of the evidence, not its admissibility. See Apple Inc. v. Motorola, Inc., 757 F.3d 1286, 1326 (Fed. Cir. 2014) (“Here, whether these licenses are sufficiently comparable such that Motorola’s calculation is a reasonable royalty goes to the weight of the evidence, not its admissibility.”); accord ActiveVideo Networks, Inc. v. Verizon Commc’ns, Inc., 694 F.3d 1312, 1333 (Fed. Cir. 2012) (“Although we may not have decided these evidentiary issues the same way had we presided over the trial, the district court did not abuse its discretion.”). In each case, district courts must assess the extent to which the proffered testimony, evidence, and arguments would skew unfairly the jury’s ability to apportion the damages to account only for the value attributable to the infringing features.

As the testimony at trial established, licenses are generally negotiated without consideration of the EMVR, and this was specifically true with respect to the Ericsson licenses relating to the technology at issue. Making real world, relevant licenses inadmissible on the grounds DLink urges would often make it impossible for a patentee to resort to license-based evidence. Such evidence is relevant and reliable, however, where the damages testimony regarding those licenses takes into account the very types of apportionment principles contemplated in Garretson. In short, where expert testimony explains to the jury the need to discount reliance on a given license to account only for the value attributed to the licensed technology, as it did here, the mere fact that licenses predicated on the value of a multi-component product are referenced in that analysis—and the district court exercises its discretion not to exclude such evidence—is not reversible error. . . .

We do conclude, however, that, when licenses based on the value of a multi-component product are admitted, or even referenced in expert testimony, the court should give a cautionary instruction regarding the limited purposes for which such testimony is proffered if the accused infringer requests the instruction. The court should also ensure that the instructions fully explain the need to apportion the ultimate royalty award to the incremental value of the patented feature from the overall product. As to the first, while D-Link did ask for a generic instruction on the EMVR, it did not ask for an instruction specifically referencing the licenses or the testimony relating thereto about which it objected. On the second, while the court told the jury about the Georgia-Pacific factors—which do take the concepts of apportionment into account to some extent—it did not separately caution the jury about the importance of apportionment. . . . As explained in Section B.2 below, we need not determine whether D-Link preserved its objections to these instructions or, if it did, whether it was prejudiced by the instructions actually given on these issues, because we vacate the damages award for other reasons.

2.  The other major damages issues related to the calculation of the (F)RAND royalty.  First, D-Link argued that "the district court reversibly erred by giving the jury the customary Georgia-Pacific factors because many of those either are not applicable, or may be misleading, in the RAND context. D-Link further contends that the district court erred by refusing to instruct the jury to consider patent hold-up and royalty stacking" (p.45).  Here the court launches into an extended riff on the Georgia-Pacific factors, concluding (correctly, in my view) that they are not the be-all and end-all in calculating reasonable royalties, either in the everyday context or in the FRAND context: 

Although we have never described the Georgia-Pacific factors as a talisman for royalty rate calculations, district courts regularly turn to this 15-factor list when fashioning their jury instructions. Indeed, courts often parrot all 15 factors to the jury, even if some of those factors clearly are not relevant to the case at hand. And, often, damages experts resort to the factors to justify urging an increase or a decrease in a royalty calculation, with little explanation as to why they do so, and little reference to the facts of record. . . . 

In a case involving RAND-encumbered patents, many of the Georgia-Pacific factors simply are not relevant; many are even contrary to RAND principles. . . . For example, factor 4 is “[t]he licensor’s established policy and marketing program to maintain his patent monopoly by not licensing others to use the invention or by granting licenses under special conditions designed to preserve that monopoly.” Georgia-Pacific, 318 F. Supp. at 1120. Because of Ericsson’s RAND commitment, however, it cannot have that kind of policy for maintaining a patent monopoly. See Microsoft, 2013 WL 2111217, at *18. Likewise, factor 5—“[t]he commercial relationship between the licensor and licensee”—is irrelevant because Ericsson must offer licenses at a non-discriminatory rate. Georgia-Pacific, 318 F. Supp. at 1120; see Microsoft, 2013 WL 2111217, at *18. 

Several other Georgia-Pacific factors would at least need to be adjusted for RAND-encumbered patents—indeed, for SEP patents generally. For example, factor 8 accounts for an invention’s “current popularity,” which is likely inflated because a standard requires the use of the technology. Georgia-Pacific, 318 F. Supp. at 1120. Factor 9—“utility and advantages of the patented invention over the old modes or devices,” J.A. 225—is also skewed for SEPs because the technology is used because it is essential, not necessarily because it is an improvement over the prior art. Factor 10, moreover, considers the commercial embodiment of the licensor, which is also irrelevant as the standard requires the use of the  technology. Other factors may also need to be adapted on a case-by-case basis depending on the technology at issue. Consequently, the trial court must carefully consider the evidence presented in the case when crafting an appropriate jury instruction. In this case, the district court erred by instructing the jury on multiple Georgia-Pacific factors that are not relevant, or are misleading, on the record before it, including, at least, factors 4, 5, 8, 9, and 10 of the Georgia-Pacific factors.7 

7 Reference to irrelevant Georgia-Pacific factors would not—in most instances—be sufficiently prejudicial to warrant reversal. Here, however, we find the combination of errors in the jury instructions merit the remand we order.

Trial courts should also consider the patentee’s actual RAND commitment in crafting the jury instruction. Ericsson agrees that it is under a binding obligation to license the patents at issue on the RAND terms it pledged to the IEEE. The district court should have turned to the actual RAND commitment at issue to determine how to instruct the jury. In this case, Ericsson promised that it would “grant a license under reasonable rates to an unrestricted number of applicants on a worldwide basis with reasonable terms and conditions that are demonstrably free of unfair discrimination.” J.A. 17253. Rather than instruct the jury to consider “Ericsson’s obligation to license its technology on RAND terms,” J.A. 226, the trial court should have instructed the jury about Ericsson’s actual RAND promises. “RAND terms” vary from case to case. A RAND commitment limits the market value to (what the patent owner can reasonably charge for use of) the patented technology. The court therefore must inform the jury what commitments have been made and of its obligation (not just option) to take those commitments into account when determining a royalty award. 

To be clear, we do not hold that there is a modified version of the Georgia-Pacific factors that should be used for all RAND-encumbered patents. Indeed, to the extent D-Link argues that the trial court was required to give instructions that mirrored the analysis in Innovatio or Microsoft, we specifically reject that argument. See Oral Argument at 16:16, Ericsson, Inc. v. D-Link Sys., Inc.,2013-1625, available at http://oralarguments.cafc.uscourts.gov/default.aspx?fl=2013-1625.mp3 (“Our argument was the following on RAND and it doesn’t rely upon any of the evidence that went in during the two hour jury wave portion. It relies upon the request for instructions, basically building on the Innovatio decision by Judge Holderman and the Microsoft decision by Judge Robart . . . .”).8 We believe it unwise to create a new set of Georgia-Pacific-like factors for all cases involving RAND encumbered patents. Although we recognize the desire for bright line rules and the need for district courts to start somewhere, courts must consider the facts of record when instructing the jury and should avoid rote reference to any particular damages formula.

8 We express no opinion on the methodologies employed in these district court cases—which may yet come before this court—or on their applications to the facts at issue there. The facts in those cases, and the decisionmakers involved, differ from those at issue here. We address only the record before us and what a jury must be instructed when RAND-encumbered patents are at issue and the jury is asked to set a RAND royalty rate.

3. Finally, the court comes to the most important issue of all, how to apportion value to the SEPs in suit.  The court concludes that the patentee is entitled to an award that reflects the incremental value of its technology, but not the value of the standard.  This is, I think, an extremely interesting theoretical issue; and while I agree that the patentee should not extract any of the holdup value (value derived from the fact that the implementer would incur substantial switching costs ex post), and I'm not entirely sure that the patentee should never obtain any of the value of standardization, if by that we mean the ability of the patent to enable interoperability which can be realized only if the patent is adopted into a standard.  (I may have more to say about this at another time.) Anyway, here's what the court says: 

As with all patents, the royalty rate for SEPs must be apportioned to the value of the patented invention. Garretson, 111 U.S. at 121; see also Westinghouse Elec. & Mfg. Co. v. Wagner Elec. & Mfg. Co., 225 U.S. 604, 617 (1912) (“[Plaintiff] was only entitled to recover such part of the commingled profits as was attributable to the use of its invention.”). When dealing with SEPs, there are two special apportionment issues that arise. First, the patented feature must be apportioned from all of the unpatented features reflected in the standard. Second, the patentee’s royalty must be premised on the value of the patented feature, not any value added by the standard’s  adoption of the patented technology. These steps are necessary to ensure that the royalty award is based on the incremental value that the patented invention adds to the product, not any value added by the standardization of that technology. . . .

Turning to the value of a patent’s standardization, we conclude that Supreme Court precedent also requires apportionment of the value of the patented technology from the value of its standardization. In Garretson, the Supreme Court made clear that, “[w]hen 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.” Garretson, 111 U.S. at 121 (emphases added). In other words, the patent holder should only be compensated for the approximate incremental benefit derived from his invention.

This is particularly true for SEPs. When a technology is incorporated into a standard, it is typically chosen from among different options. Once incorporated and widely adopted, that technology is not always used because it is the best or the only option; it is used because its use is necessary to comply with the standard. In other words,widespread adoption of standard essential technology is not entirely indicative of the added usefulness of an innovation over the prior art. Id. This is not meant to imply that SEPs never claim valuable technological contributions. We merely hold that the royalty for SEPs should reflect the approximate value of that technological contribution, not the value of its widespread adoption due to standardization.

Because SEP holders should only be compensated for the added benefit of their inventions, the jury must be told to differentiate the added benefit from any value the innovation gains because it has become standard essential. Although the jury, as the fact finder, should determine the appropriate value for that added benefit and may do so with some level of imprecision, we conclude that they must be told to consider the difference between the added value of the technological invention and the added value of that invention’s standardization. Indeed, Ericsson admitted at oral argument that the value of standardization should not be incorporated into the royalty award.

4. Finally, the court concludes that the district court acted within its discretion in not instructing the jury on patent holdup or royalty stacking:

In deciding whether to instruct the jury on patent hold-up and royalty stacking, again, we emphasize that the district court must consider the evidence on the record before it. The district court need not instruct the jury on hold-up or stacking unless the accused infringer presents actual evidence of hold-up or stacking. Certainly something more than a general argument that these phenomena are possibilities is necessary. . . . 

In this case, we agree with the district court that DLink failed to provide evidence of patent hold-up and royalty stacking sufficient to warrant a jury instruction. . . . If D-Link had provided evidence that Ericsson started requesting higher royalty rates after the adoption of the 802.11(n) standard, the court could have addressed it by instructing the jury on patent hold-up or, perhaps, setting the hypothetical negotiation date before the adoption of the standard.10

10 One amicus suggests that the jury always should be told to place the date of the hypothetical negotiation as of the date of the adoption of the standard (if that date predates the infringement) so as to discount any value added by the standardization. See, e.g., AAI Br. 13–16; see also Microsoft, 2013 WL 2111217, at *19 (“[T]he parties to a hypothetical negotiation under a RAND commitment would consider alternatives that could have been written into the standard instead of the patented technology.”). D-Link did not request any such instruction, however. Accordingly, we do not address whether shifting the timing of the hypothetical negotiation is either appropriate or necessary.

On this last issue, I think it would have been helpful if the court had clarified that, at least in the SEP context, the date of the hypothetical negotiation should be pre-standard adoption, as Norman Siebrasse and I discuss in a recently posted paper.

5.  In summary, then:

. . . we find that the district court committed legal error in its jury instruction by: (1) failing to instruct the jury adequately regarding Ericsson’s actual RAND commitment; (2) failing to instruct the jury that any royalty for the patented technology must be apportioned from the value of the standard as a whole; and (3) failing to instruct the jury that the RAND royalty rate must be based on the value of the invention, not any value added by the standardization of that invention—while instructing the jury to consider irrelevant Georgia-Pacific factors. We think that these errors collectively constitute prejudicial error. . . .  We therefore vacate the jury’s damages award and remand for further proceedings consistent with this opinion. On remand, the court should also be careful to assure that the jury is properly instructed on the apportionment principles laid out in Garretson and on the proper evidentiary value of licenses tied to the entire value of a multi-component product. Because we vacate the jury’s damages award, moreover, we also vacate the court’s ongoing royalty award.