Referral to CJEU of Questions Relating to Recovery of Costs in IP Litigation

Yesterday IPKat reported on a referral of questions to the Court of Justice for the European Union from the Antwerp Court of Appeal regarding whether Belgian law, which according to the defendant in the case severely limits the recovery of costs, is consistent with article 14 of the Enforcement Directive.  I may have more to say about this in another post, but for now will simply direct interested readers (who haven't already seen it) to the IPKat post, here. 

Injunctions in India

1.  SpicyIP has had some interesting posts recently on injunctions in India.  In December, 2014, Thomas J. Vallianeth published two posts (here and here) on a contractual dispute between Micromax and OnePlus, in which Judge Nandrajog of the High Court of Delhi (link here) expressed a strong disinclination for "ad interim" injunctions--by which I take the judge to be referring to something similar to what in the U.S. would be referred to as a temporary restraining order, see paras. 16(ii), 31 (though in this particular case the defendant was present at the initial hearing):

An ad-interim injunction is normally issued when a very strong prima-facie case is made out by the plaintiff and the injury to the plaintiff is writ large if the defendant is not restrained from doing the activity which causes the injury to the plaintiff. In such a case the balance of convenience would obviously be in favour of the plaintiff. Since interim injunctions affect the right of a defendant, the principle of natural justice would warrant the defendant to be heard before an order adverse to the defendant’s right is passed. A delicate balance has to be struck between the right of the plaintiff and the right of the defendant at the stage of granting an ad-interim injunction. Only if a Court were to find that so grave and so irreparable is the injury that even a day’s delay cannot be brooked, and so strong is the prima facie case made out, only then would a Court be justified in granting an ad-interim injunction and thereafter proceeding to consider whether to confirm the same or not after hearing the defendant. It would be a situation akin to a post decisional hearing.

2.  More recently, on January 9 Judge Manmohan Singh of the Delhi High Court entered a preliminary injunction in favor of Novartis and against Cipla with regard to the latter's plans to market the drug Indacaterol.  Citing the U.S. decision in eBay and the Indian decision in Hoffman-La Roche, the court held that the public interest is a factor to be considered in deciding whether or not to grant an injunction.  Nevertheless, on balance, the court denied the injunction, partly because the evidence thus far would not have enabled the court to calculate an appropriate royalty, and partly because (if it wishes to do so) the defendant has the option of trying to obtain a compulsory license under sections 83 and 84 of the Indian Patent Act from the appropriate tribunal.  The text of the opinion is available here, and there are discussions of it by Madhulika Vishwanathan on SpicyIP and by Madhur Singh in Bloomberg BNA's World Intellectual Property Report (available here, behind a paywall).  

Canadian Court Rejects the Principle that Non-Infringing Alternatives Limit the Recovery of Lost Profits

One of the recurring issues in patent enforcement is the following.  Suppose that P makes and sells products embodying its patented invention X.  D makes and sells products that infringe the patent.  P sues D and requests a judgment for lost profits on the sales it lost to D.  D responds with evidence that there is a nonpatented noninfringing alternative to X--call it Y--that D could have made and sold instead of X, and that consumers would have considered Y to be a perfect substitute for X.  Is X entitled to lost profits nonetheless, on the theory that regardless of what would have happened in the "but for" world--the world in which D used the noninfringing alternative--in the real world X lost sales, and hence profits, as a result of having to compete with X's infringing products?  Or should X recover no lost profits because in that but-for world it would have lost just as many sales and just as much profit as it did in the real world?  (To think of it another way, if the economic value of a technology is its value in comparison with alternatives, and if Y is a perfect substitute for X, then X has no economic value over the nonpatented alternative, and P should recover nothing.)  As I explain in my book, different patent systems answer these questions in different ways.  The general rule in the U.S., dating all the way back to the nineteenth century, is that under the circumstances described above the patent owner should recover no lost profits (see pp. 111-12).  On the other hand, a nineteenth century decision from the U.K., United Horse-Shoe & Nail Co. v. John Stewart & Co. (1888) L.R. 13 App. Case 401 (H.L.), takes precisely the opposite view, and courts within the U.K.--as well as some in Canada and Australia--have followed United Horse Shoe ever since (see pp. 187-91).  Also lining up with the U.K. on this issue are, possibly, Germany and Japan (see pp. 263-64, 314), while the French cases appear more consistent with the U.S. rule (see p. 265).  And of course there can be numerous variations of the above hypothetical:  for example, maybe Y is an imperfect substitute that would have appealed to some but not all of D's clientele; maybe Y itself was a patented alternative, which complicates matters; maybe D would have sold just as many products using Y but would have done so at higher cost, in which case even under the U.S./French rule it seems that P should be entitled to a nonnegligible reasonable royalty; and so on.  My own view, as expressed in my book, on this blog, and elsewhere, is that from an economic standpoint the rule followed in the U.S. and France is correct, and that United Horse-Shoe was wrongly decided.

Anyway, Professor Norman Siebrasse recently called my attention to a Canadian trial court decision, Eli Lilly & Co. v. Apotex Inc., 2014 FC 1254 (Jan. 23, 2015), that lines up with United Horse-Shoe  on this issue.  (It doesn't appear to be up yet on the Federal Court's website, but here is a link to my copy of the decision.)  Professor Siebrasse will be posting a more detailed discussion of the case on his Sufficient Description Blog in the near future--a different write-up by Jennifer Wilkie and Adam Heckman has already appeared on the Gowlings firm's website here--and I needn't repeat here the arguments I've made in the past in support of my view.  I would note two things, however.  First, Apotex cited one of my blog posts in support of its position that the court should take noninfringing alternatives into account, and the court in turn cited that post in paragraphs 25 and 54-56.  So while the court rejected my view, this marks (to my knowledge) the first time the blog has been cited in a judicial decision.  (Not sure if I should be happy or sad, though!)  Second, if I'm reading the opinion correctly, after rejecting the argument that noninfringing alternatives which the defendant didn't but could have used are relevant for purposes of calculating lost profits, the court goes on to award Lilly lost profits covering a subsequent period of time in which Apotex was using a purported noninfringing alternative, on the ground that but for the initial infringement Apotex wouldn't have been in the market at that point at all.  This seems to me to be a sort of springboard damages theory, but (with respect) I'm inclined to think it only compounds the error of ignoring noninfringing alternatives to award lost profits during a period of time in which the defendant was in reality--not just hypothetically--using the noninfringing alternative.

I wonder if an appeal will be taken, and if so what the Court of Appeals' take on this issue will be?     

Chinese Court Awards $12 Million in Damages for Infringement of Two Utility Models

Recently I came across an article by Song Haining in 2014 issue 4 of China Patents & Trademarks titled A Story of Battling Giants: Comments on Goer Tek Acoustics v. Knowles Electronics.  (The article does not appear to be freely available on the magazine's website yet, but interested readers may want to check back in a few weeks.)  In any event, according to Mr. Song, the parties compete in the market for micro-electrical-mechanical systems (MEMS), and both supply microphones to Apple and Samsung.  (Knowles is a U.S. company with a Chinese subsidiary, Knowles (Suzhou); Goer Tek is a Chinese firm.)  In 2013, Knowles commenced an ITC investigation and a patent infringement suit against Goer Tek in the U.S., both of which matters remain pending.  Shortly thereafter, Goer Tek filed actions in China against Knowles (Suzhou), the Chinese subsidiary, for infringement of four utility models and one patent.  Knowles filed an invalidation action against two of the utility models, but lost on one and withdrew its request regarding the other.  The actions proceeded to trial on these two utility models and judgment was entered for Goer Tek in April 2014.  (According to Mr. Song, the other three actions (involving two utility models and one patent) remain pending.)  As far as remedies are concerned:

1.  The court enjoined a retailer, Weifang Sanlian Home Electronic Appliances Co., Ltd., from selling Samsung cell phones (model GT-I9500) that contained the infringing product;

2.  The court enjoined Knowles (Suzhou) from selling or making infringing microphones; and

3.  The court ordered Knowles (Suzhou) to pay Goer Tek RMB 74.4 million, which comes to approximately U.S. $12 million.  To my knowledge, this makes the judgment one of the largest ever in China, though not quite as large as the RMB 330 million awarded by the Wenzhou Intermediate People’s Court in the 2007 case of Chint Group Corp. v. Schneider Electric Low-Voltage (Tianjin) Co. (see my book p.355).

Analyzing the case, Mr. Song argues that the injunction is disproportionately harsh as to the retailer, given the relatively small value of the infringing component in comparison with the price of a cell phone, but states that under Chinese law an injunction remains the "default remedy for patent infringement."  He also notes, however, that there are some Chinese precedents permitting courts to withhold injunctions in the public interest, including a case titled Zhuhai City Jingyi Glass Engineering Co. Ltd. v. Guangzhou Baiyun International Airport Co., Ltd., where a court denied an injunction against an airport due to its "special nature as a public transport facility."  (See also the discussion in my book at pages 349-50 of China Environmental Project Co., Ltd. v. Fujikasui Engineering Co., Ltd., Huayang Electric Power Co., Ltd., another case in which a Chinese court denied an injunction on public interest grounds.)  Moreover, Mr. Song cites "an internal draft document being circulated among Chinese IP professors as of June 2014" in which "the Supreme People's Court proposes that, in addition to 'public interest', 'serious imbalance of interests between parties' might also justify an exception to injunction."  As I note in my book (pp. 350-51), Supreme People's Court Vice President Cao Jianming made a similar suggestion in a 2008 speech, so perhaps it would not be surprising if China formally adopted such a rule in the near future.

As for damages, the court awarded lost profits calculated by taking the number of infringing products (estimated from sales data disclosed by the defendant and from "import/export data from Chinese customs") and multiplying it by the "average profit rate in the industry."  This sounds very similar to a procedure used in Japan under article 102(1) of the Japan Patent Act, which states in relevant part and subject to some qualifications that “the amount of damage sustained . . . may be presumed to be the amount of profit per unit of articles which would have been sold by the patentee . . . if there had been no such act of infringement, multiplied by the quantity . . . of articles assigned by the infringer . . . .”  To my mind, however, the procedure seems problematic, since it may well be the case that the infringer would have been able to make some or all of its sales by using a noninfringing alternative--though if I understand Mr. Song correctly, in this case the defendant didn't provide any rebuttal evidence.  In any event, lost profits are not awarded very frequently in China, as I discuss in my book at pp. 354-55; so-called statutory damages are much more common.  So for that reason alone the Goer Tek case is significant, and I am thankful to Mr. Song for bringing it to my attention in his paper.   

False Allegations of Patent Infringement in Japan

The September 2014 issue of AIPPI-Journal of Japanese Group of AIPPI has a short article by Yosuke Kurita of a case titled Iris Ohyama, Inc. v. Y, Tokyo District Court, Judgment of December 19, 2013, Case No. 2011 (Wa) No. 30214.  According to the article, the defendant owns a patent on an "energy saving lamp with sensor."  The defendant sought an injunction against the plaintiff's importation and sales of a product that the defendant alleged was infringing, and also sent letters to two other firms (retailers of plaintiff's product) making this same allegation against the plaintiff.  The plaintiff filed suit for a declaratory judgment of noninfringement and for an injunction against the defendant's alleged unfair competition.  The court concluded that the plaintiff's product did not infringe and awarded it the requested declaratory judgment.  On the unfair competition claim, the relevant statute states (in this unofficial translation available from the OECD) in article 3(1) that "A person whose business interests have been infringed or are likely to be infringed by unfair competition may seek an injunction suspending or preventing the infringement against the person that infringed or is likely to infringe such business interests," and article 2(1)(xiv) defines "unfair competition" to include, among other things, "acts of making or circulating a false allegation that is injurious to the business reputation of another person in a competitive relationship."  The court concluded that a "competitive relationship" between the plaintiff and defendant existed, on the ground that "existence of a likelihood of competition occurring in the market suffices from the perspective of the purpose . . .  of the Unfair Competition Prevention Act, that is, ensuring fair competition among business operators, even if there is no competition in the actual market.  Sela has also made its way into Japan, and is in a competitive relationship with the plaintiff.  In addition, the defendant is the representative of Sela and has the patent right.  Therefore, it is recognized that there is a likelihood of competition occurring in the market in relation of the business of selling lamps with a sensor" (p.347).  

The article doesn't indicate that the plaintiff sought any damages for the alleged unfair competition,  perhaps because no damages would have been available under the damages provisions of the unfair competition law.  The relevant portions of those provisions read as follows:

Article 4 (Damages)

A person who intentionally or negligently infringes on the business interests of another person by unfair competition shall be liable for damages resulting therefrom. However, this Article shall not apply to damages resulting from the use of a trade secret after the rights prescribed in Article 15 have extinguished pursuant to the said Article.

Article 5 (Presumption of amount of damages, etc.)

(1) Where a person whose business interests have been infringed by unfair competition listed in items 1 to 9 or item 15 of Article 2(1) . . . (hereinafter referred to as the "infringed person" in this paragraph) claims damages caused by such an infringement from a person who has intentionally or negligently infringed such business interests, and where the infringer has sold or otherwise transferred the articles constituting the act of infringement, the quantity of the articles sold or transferred (hereinafter referred to as the "transferred quantity" in this paragraph) multiplied by the amount of profit per unit of the articles that the infringed person could have sold in the absence of the infringement may be deemed as the amount of damages suffered by the infringed person, provided it does not exceed the amount attainable by the infringed person's capability to sell or conduct other acts concerning said articles. However, where there are any circumstances that would have prevented the infringed person from selling the quantity of articles equivalent to all or part of the transferred quantity, an amount corresponding to the quantity relevant to such circumstances shall be deducted.

(2) Where a person whose business interests have been infringed by unfair competition claims damages caused by a person who intentionally or negligently infringed such business interests and received profits through the act of infringement, the amount of such profits shall be presumed to be the amount of damages suffered by the person whose business interests were infringed. . . .

(4) The provisions of the preceding paragraph shall not preclude a claim for damages exceeding the amount prescribed in the paragraph. In such a case, if the person who infringed such business interests did not do so intentionally or through gross negligence, the court may take this into consideration in determining the amount of damages. . . .

Article 9 (Determination of reasonable damages)

In a lawsuit for the infringement of business interests by unfair competition, where damages were found and it is extremely difficult to prove the facts necessary for proving the amount of damages due to the nature of said facts, the court may determine a reasonable amount of damages based on the overall purport of the oral arguments and the results of the examination of evidence.

Presumably, then, if the defendant hasn't yet sold any products in competition with the plaintiff, which I take it to be the case here based on the court's discussion of "likelihood of competition," the only recourse would have been article 9; and perhaps there were no actual lost sales on which to base a damages award, which would have made an undertaking for damages futile.  Interesting nonetheless to see what the statute says about damages for unfair competition, including unfair competition based on wrongful claims of patent infringement, and to compare the above provisions with the (somewhat similar) corresponding provisions on patent damages found in article 102 and 105-3 of the Japanese Patent Act (available in unofficial translation here).

For further discussion of patent damages and declaratory judgments in Japan, see my book pp. 307-331.

Some New Papers on Wrongful Enforcement

I continue to collect materials on wrongful patent enforcement in preparation for what I hope eventually will turn into a book project.  Here are some recent papers relevant to the subject:

1.  Paul  Gugliuzza has posted a paper on ssrn titled Patent Trolls and Preemption.  Here is a link to the paper, and here is the abstract:

Patent law is usually thought to be the domain of the federal government, not state governments. Yet eighteen states have recently passed statutes outlawing false or bad faith assertions of patent infringement. The statutes are aimed at fighting so-called patent trolls, particularly those who send letters to thousands of users of allegedly infringing technology—as opposed to the manufacturers of that technology—demanding that each user purchase a license for a few thousand dollars or else face an infringement suit. The Federal Circuit, however, has held that state-law claims challenging acts of patent enforcement are preempted by the federal Patent Act unless the patent holder made  infringement allegations with knowledge that the allegations were objectively baseless. No court has yet applied this rule to the new state statutes, but it will likely provide patent holders with nearly absolute immunity from liability under the new laws.

Although the Federal Circuit has called this immunity a matter of “preemption,” a close examination of the court’s decisions reveals that the rule is not grounded in the Supremacy Clause but in the First Amendment right to petition the government. Unlike the Supremacy Clause, the First Amendment limits the power of the federal government, not just state governments, so patent holders will also be able to invoke this immunity to thwart impending federal initiatives to fight patent trolls, such as unfair competition proceedings brought by the Federal Trade Commission and proposals in Congress to outlaw false and misleading statements made in patent demand letters.

This article argues that the broad immunity the Federal Circuit has conferred on patent holders is wrong as a matter of doctrine, misguided as a matter of policy, and inconsistent with a long history of courts enjoining unfair and deceptive acts of patent enforcement. Accordingly, the article suggests a reimagined immunity standard that would not shield extortionate schemes of patent enforcement but would still respect a patent holder’s right to make legitimate allegations of infringement.

2.  David Lee Johnson has published a student note in volume 71 of the Washington & Lee Law Review review titled Facing Down the Trolls:  States Stumble on the Bridge to Patent-Assertion Regulation.  Here is a link to the published paper, and here is a portion of the introduction:

To determine the proper relationship between state and federal regulation of the patent system, it is first helpful to identify the patent uses that states are attempting to regulate. To that end, Part II introduces the players in the patent ecosystem. Part III describes the Vermont and Oregon bad-faith patent assertion laws and similar state bills. To assess whether state bad-faith patent-assertion legislation is preempted by federal patent law, Parts IV and V develop the general doctrine of federal preemption and its specific application to patent law. Part VI applies this preemption analysis to the Vermont law to reach the conclusion that much of the law is likely dead letter because it is preempted by federal patent law. Part VII argues that the inoperability of the law is normatively justified, especially in light of the potential value of preempted law, described in Part VIII.

 3. Another recent paper (not specific to patent law) is Thomas J. Miceli & Michael P. Stone, "Piggyback" Lawsuits and Deterrence:  Can Frivolous Litigation Improve Welfare?, 39 International Review of Law and Economics 49 (2014).  Here is a link to the paper, and here is the abstract:

Previous literature on frivolous lawsuits has focused on litigation costs and the optimal settlement-trial decision of defendants, but has not examined how they affect deterrence. This paper considers whether there are circumstances under which frivolous suits might actually increase deterrence, and thereby possibly improve welfare. The reason this is possible is that in a costly legal system, injurers will generally be underdeterred because they will ignore the litigation costs of plaintiffs. The fact that some uninjured plaintiffs will succeed in obtaining settlements may therefore affect the care and activity choices of injurers in a socially valuable way.

The authors caution, however, that "[t]he fact that frivolous suits may, in some circumstances, improve welfare should not . . . be interpreted as a justification for curbing efforts to discourage meritless cases," and they suspect that, "as a matter of public policy," the negative consequences of frivolous litigation "would overwhelm any of the considerations raised in this paper."

Hoppe-Jänisch on Important German Patent Cases Since 2013

Daniel Hoppe-Jänisch recently published an article titled Die Rechtsprechung der Instanzgericthe zum Patent- und Gebrauchsmusterrecht seit dem Jahr 2013 ("The Patent and Utility Model Case Law of the Lower Courts Since 2013") in the December 2014 issue of GRUR RR.  Here is the abstract (my translation from the German):

The essay follows the report appearing in the October 2013 issue of GRUR-RR.  Included are selected decisions published since the middle of 2013.  In contrast to the last essay, a section is also dedicated to the Arbeitnehmererfinderrecht [the law of employee-inventor rights].  The publication practice of the courts is still greatly varied, with the Düsseldorf courts still being especially active.  The accumulation of decisions of Düsseldorf origin is attributable to this publication practice.

On the issue of remedies in particular, Mr. Hoppe-Jänisch discusses some cases on injunctions, including one in which he reports that the Düsseldorf district court concluded that a risk of recurring infringement is not eliminated by virtue of the fact that a defendant is no longer in possession of the challenged article and has ceased distribution, unless it is evidently incapable of making and distributing the patented article; and another in which he reports that the Hamburg district court held that the exhibition of a not yet marketable medicine did not give rise to a danger of imminent infringement (Erstbegehungsgefahr) through the introduction of an identical, marketable end product.  Mr. Hoppe-Jänisch also discusses some cases on damages, including one on infringer's profits in which he reports that the Düsseldorf district court held that a court should consider whether the infringer chose a protected configuration despite the existence of technical alternatives (whereby it might be inferred that the infringer attributed significance to the invention for its sales success).  On the other hand, the court suggested that a lower price for the infringing article could reduce the portion of the profits attributable to the infringement, if it cannot be established that precisely the use of the invention opened up the possibility of such a favorable price reduction.  (Who has the burden of proof on this issue, I wonder?)  The court also noted that the significance of the patent to the defendant's profit recedes to the extent the product also makes use of other protected rights.  These other rights are to be considered, however, only if they are valid and actually being used, and the infringer bears the burden of proof on these issues.  (I imagine that could turn out to be a double-edged sword for the infringer, if any such argument could be used against it in a proceeding involving one of those other protected rights!)  Mr. Hoppe-Jänisch also mentions the OLG Karlsruhe's decision in Foliendruckverfahren, a case I blogged about here this past April, in which the court held (among other things) that on the facts of the case it was appropriate to use the entire value of the end product as the royalty base, and that the defendant may be liable for an additional payment where a real-world licensee would have had to pay a default payment for failing to pay its license fee on time.  

Other sections of the paper discuss stays and preliminary injunctions, which I may address in a future post.   

Updated Version of Contreras and Gilbert Paper on FRAND and Other Royalties

Jorge Contreras and Richard Gilbert have posted on ssrn an updated version of their paper A Unified Framework for RAND and Other Reasonable Royalties, which is forthcoming in the Berkeley Technology Law Journal.  I was favorably impressed by the initial version; the new version incorporates responses to feedback from several commentators, including me.  Here is a link, and here is the abstract:

The framework for calculating “reasonable royalty” patent damages has evolved over the years to a point at which, today, it is viewed by many commentators as potentially misleading and untethered from its original purpose. We offer a proposal to modify the framework for determining reasonable patent royalties that is based on recent scholarly and judicial analyses of standards-essential patents that are subject to commitments to license on terms that are reasonable and non-discriminatory (RAND). Litigated cases have applied the traditional Georgia-Pacific factors to assess RAND royalty rates with modifications to account for the circumstances of the RAND commitment. We propose that the reasonable royalty analysis should be conducted in essentially the same manner for all patents, whether or not they are encumbered by RAND commitments. We find considerable support for our approach in the historical development of U.S. patent law prior to the advent of the Georgia-Pacific test. Our approach focuses on the technical and economic characteristics of allegedly infringed patents and their incremental value to the overall product offering. 

Some New Papers on Patent Remedies

1.  Daryl Lim's paper Standard Essential Patents, Trolls, and the Smartphone Wars:  Triangulating the End Game, is now available in 119 Penn State Law Review 1 (2014).  (I mentioned an earlier version of the paper here in September.)  The paper is not available on the journal's website yet, but it is on Westlaw, and what appears to be a near-final version is available on ssrn.  Here is the abstract of the published version:

Few legal issues in recent years have captured the public's attention more powerfully than litigation over standard essential patents (“SEPs”). This Article explains how SEP litigation overlaps with two other major centers of patent litigation--litigation involving smartphones and patent assertion entities (“PAEs”). It observes that attempting to pre-empt patent hold-ups by imposing blanket ex ante disclosure obligations and royalty caps on standard setting organizations (“SSOs”) is misdirected and counterproductive. Instead, the solution lies in clear and balanced rules to determine “fair, reasonable and non-discriminatory” (FRAND) royalties and injunctive relief. This solution will help parties make more realistic assessments of their options and help adjudicators resolve SEP disputes.

Correctly framed, implementers bear the burden of proving the breach of a FRAND commitment. FRAND royalties should, in the absence of comparable licenses, focus on apportioning the profits based on the relative importance of the patented technology in the covered product. Royalties should be measured at the time the standard is set but generally should not be discounted for the possibility of invalidity and non-infringement. Discriminatory licenses can be hard to detect, but targeted initiatives and improved transparency would make the task easier. Injunctions should be granted based the wording and intent of the relevant FRAND commitment, conduct of the parties, and proof that the technology drove the sales of the component or product on which the relief is sought. More broadly, courts must understand both the limits and opportunities of the antitrust and patent laws. While useful in arresting ex ante misconduct and attempts to elide FRAND commitments through patent assignments, antitrust is largely irrelevant in addressing patent hold-ups; patent law has a role in both improving patent quality and deterring vexatious litigation.

2. David O. Taylor's paper Using Reasonable Royalties to Value Patented Technology, is now available in 49 Georgia Law Review 79 (2014).  Like Professor Lim's paper, this one is not up yet on the journal's website yet, but it is on Westlaw; and an earlier version, which I mentioned here in April, is still available on ssrn.  Here is the abstract from the ssrn version:

In the last several years, commentators have expressed serious concerns with the state of the law governing awards of reasonable royalties as damages in patent infringement cases. Given these concerns, the proper assessment of royalties has been a recent, frequent topic for debate among economists and legal scholars. At the same time, all three branches of the federal government have studied ways to improve the law governing reasonable royalties. In this Article, I reframe the ongoing debate by identifying and exploring two basic paradigms for calculating reasonable royalties: valuing patent rights and valuing patented technology. The traditional paradigm, valuing patent rights, reflects a tort-law make-whole conception of compensatory damages. Notably, however, the alternative paradigm, valuing patented technology, in various respects explains the course of the common law governing the method for calculating reasonable royalties, comports with the public policies identified by courts as guiding the award of reasonable royalties, and, moreover, if fully adopted may have significant benefits. I therefore consider several reforms that would focus the law governing reasonable royalty determinations on the value of patented technology, and I highlight several open questions related to full adoption of this alternative paradigm.

3.  In addition, I may as well note that I recently posted new versions of two of my own coauthored papers on ssrn:  Anticompetitive Injunctions (coauthored with Erik Hovenkamp) and A New Framework for Determining Reasonable Royalties in Patent Litigation (coauthored with Norman Siebrasse).  Get 'em while they're hot. 

Divided Federal Circuit Affirms Finding of Willfulness in Long-Running Bard v. Gore Litigation

This morning the Federal Circuit published the latest installment in the ongoing saga of Bard Peripheral Vascular, Inc. v. W.L. Gore & Associates, available here.  The patent in suit, which "relates to prosthetic vascular grafts made of highly-expanded polytetrafluoroethylene ('ePTFE')," can be traced back to an application filed in 1974.  Along the way the parties have disputed who was entitled to the patent and whether Gore's employee Cooper should have been named as a coinventor, among other issues.  These issues ultimately were resolved in favor of Bard, and in 2003 Bard and inventor Goldfarb filed suit against Gore for infringement.  A jury returned a verdict for Bard, which was affirmed on appeal.  The jury also found that Gore willfully infringed, but in 2012 the Federal Circuit 

vacated the parts of its opinion discussing willfulness and allowing enhanced damages and attorneys’ fees. Bard Peripheral Vascular, Inc. v. W.L. Gore & Assocs., Inc., 682 F.3d 1003, 1005 (Fed. Cir. 2012) (“Bard II”). It held that as to the threshold determination of willfulness, “the objective determination of recklessness, even though predicated on underlying mixed questions of law and fact, is best decided by the judge as a question of law subject to de novo review (p.3).

On remand, the district court again found "'that Defendant, as a "reasonable litigant," could not have "realistically expected" its defenses to succeed'” and entered a finding of willfulness.  A divided panel of the Federal Circuit has now affirmed.

Writing for the majority, Judge Prost notes that

under Bard II, we review de novo the district court’s determination whether Gore’s “position is susceptible to a reasonable conclusion of no infringement.” Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292, 1310 (Fed. Cir. 2011). Objective recklessness will not be found where the accused infringer has raised a “substantial question” as to the validity or noninfringement of the patent. Spine Solutions, Inc. v. Medtronic Sofamor Danek USA, Inc., 620 F.3d 1305, 1319 (Fed. Cir. 2010); DePuy Spine, Inc. v. Medtronic Sofamor Danek, Inc., 567 F.3d 1314, 1336 (Fed. Cir. 2009).

On remand, the district court evaluated several defenses raised by Gore and determined that none of them were objectively reasonable. On appeal, Gore appeals only its determination with respect to Gore’s inventorship defense. . . .  Gore’s argument is based on the fact that its employee, Peter Cooper, supplied the particular ePTFE tubing that Goldfarb used in making his successful vascular graft (the “2-73 RF” graft). In Gore’s view, Cooper furnished to Goldfarb “the embodiment of the invention before Goldfarb conceived the invention using that embodiment.” Bard III, at 7 (pp. 10-11).

Applying de novo review, the majority first "reject[s] Gore’s argument that the mere fact a member of the previous panel dissented on this issue indicates that its position was reasonable," asserting that "[o]therwise, we would be imposing a rule that any single judge’s dissent on the merits could preclude the determination of willful infringement" (p.11).  Judge Prost then reviews the record and concludes that "Gore’s position was not susceptible to a reasonable conclusion that the patent was invalid on inventorship grounds" (p.16).  The willfulness determination therefore is affirmed.  Moreover, since the district court in an earlier proceeding had awarded enhanced damages based on the jury's initial finding of willfulness and in Bard III  found it "unnecessary . . . to reconsider its rulings on enhanced damages and attorney's fees," 2013 WL 5670909, at *12, I assume that the award (doubling the damages from $185,589,871.02 to $371,179,742.04) stands.

Concurring in the judgment, Judge Hughes reiterated a point made by Judge O'Malley in the recent Halo v. Pulse case, namely that "the full court should review our willfulness jurisprudence in light of the Supreme Court’s recent decisions in Highmark Inc. v. Allcare Health Management Sys., Inc., 134  S. Ct. 1744 (2014) and Octane Fitness, LLC v. ICON Health & Fitness, Inc., 134 S. Ct. 1749 (2014)."  According to Judge Hughes, "[t]hose decisions call into question our two-part test for determining willfulness, In Re Seagate Tech., LLC, 497 F.3d 1360 (2007) (en banc), and our de novo standard for reviewing the district court’s willfulness determination, Bard Peripheral Vascular, Inc. v. W.L. Gore & Assocs., Inc., 682 F.3d 1003, 1006–07 (Fed. Cir. 2012) (Bard II)."  Judge Hughes believes that, as is now the case with attorneys' fee awards, the correct standard requires some deference to the district court:

This case demonstrates why de novo review of willfulness is problematic. The panel is divided over the strength of Gore’s joint inventorship defense. Each side advances a sound argument about whether the evidence in this case raises a “substantial question” of joint inventorship. And the district court, likewise, provided a thorough and well-reasoned opinion. If one of these several reasonable opinions must ultimately govern, it should be the opinion of the district judge, whose assessment of litigation positions is informed by trial experience and who has “lived with the case over a prolonged period of time.” Highmark, 134 S. Ct. at 1748.

A more deferential standard of review would be consistent with the standards for reviewing mixed questions of law and fact in other contexts. See, e.g., Highmark, 134 S. Ct. at 1748–49 (holding abuse of discretion is the proper standard for reviewing award of attorney fees in patent cases, “[a]lthough questions of law may in some cases be relevant . . . .”); Pierce v. Underwood, 487 U.S. 552, 558 (1988) (holding abuse of discretion is the proper standard for reviewing determinations of whether a litigant’s position is “substantially justified” for purposes of fee-shifting under the Equal Access to Justice Act, although the determination frequently turns on a purely legal issue). It would also be consistent with the standard for reviewing a finding of willful copyright infringement. See Dolman v. Agee, 157 F.3d 708, 715 (9th Cir. 1998) . . . .

Dissenting, Judge Newman writes that 

Precedent establishes that the objective prong of willful infringement “tends not to be met where an accused infringer relies on a reasonable defense to a charge of infringement.” Spine Solutions, Inc. v. Medtronic Sofamor Danek USA, Inc., 620 F.3d 1305, 1319–20 (Fed. Cir. 2010). When there is a “substantial question of invalidity or  unenforceability” of the patent, willful infringement cannot arise, as a matter of law. Seagate, 497 F.3d at 1371. The panel majority does not review the evidence and apply the law objectively; the court merely searches for and recites adverse evidence.

Judge Newman's lengthy review of the evidence leads her to conclude that Gore's position was reasonable and therefore that Gore did not willfully infringe.  

Judge Newman also forcefully dissents from the imposition of enhanced damages:

Even when willful infringement is found, it does not follow that punitive damages must be imposed, or that the damages must be doubled. The public benefit of Gore’s product cannot be ignored. Punitive damages are intended to discourage bad behavior, not life-saving medical devices. . . .

Extensive precedent supports judicial refusal to enhance damages when the case is close and the equities counsel moderation, not punishment. The award of punitive damages depends on both the infringer’s degree of culpability, and the injury that the infringement imposed on the patentee. Bard was awarded full recovery for its loss of business to the Gore product. The district court stated that “the Court is satisfied that a fair and full amount of compensatory money damages, when combined with a progressive compulsory license, will adequately compensate Plaintiffs’ injuries, such that the harsh and extraordinary remedy of injunction–with its potentially devastating public health consequences—can be avoided.” Bard Peripheral Vascular, Inc. v. W.L. Gore & Assocs., Inc., No. 03-CV-0597, 2009 WL 920300, at *5 (D. Ariz. Mar. 31, 2009).

The district court’s recognition of the public’s interest and medical benefits imparted by Gore’s product, and the court’s refusal to enjoin its provision, cannot be reconciled with the punitive doubling of damages. There was no showing, or even a charge, of intentional harm, as required for severe punishment as here meted out. See Restatement (Second) of Torts § 500 (1965).

Thus, regardless of whether willfulness was a supportable ruling, the doubling of the damages award is untenable.

Given the force of the concurring and dissenting opinions, I don't think we've heard the last of the Bard v. Gore story.  On the law, I'm inclined to agree with Judge Hughes that after Highmark  and Octane Fitness, the Federal Circuit's current standards for evaluating willfulness are not easily supportable.  Perhaps Judge Newman is right, however, that even under those standards punitive damages should not be imposed here.  More generally, and as I have discussed elsewhere, I don't think that economic logic supports the awarding of enhanced damages at all other than in a few narrowly circumscribed circumstances such as where the defendant has actively concealed its infringement--though whether the Federal Circuit or the Supreme Court is ever willing to go that far may be hoping for too much.  

Nestler and Hellebrandt Square Off on Rules of Thumb

The question of how best to value patent licenses, whether in negotiation, for tax purposes, or for purposes of calculating damages, is a tough one.  In theory, it makes economic sense to assume that the parties to the license would have agreed to some sort of split of the profits to be earned from the use, but of course reality may be different.  For administrability reasons, the parties themselves may prefer some sort of heuristic, based on comparable licenses or industry-wide standard rates; and in litigation comparables sometimes may be a reasonable indicator of the value of the "license" the infringer has taken.  Moreover, if we are to base royalties on a percent of the profit (real or expected), what should we assume that percent to be--and how confident can we be that only the profit derived from the infringement, and not from other factors, will be used as the base?  On the other hand, what if there are no (very similar) comparables to be had?  Are industry-wide rights an accurate enough guide for all inventions (which seems quite doubtful to me), or only some (and if so, which ones)?

In the German press, Anke Nestler and Ortwin Hellebrand recently have expressed competing views on these issues.  Regarding Dr. Nestler, in September, I posted this:

Anke Nestler has published an article titled Die Ableitung von angemessenen Lizenzsätzen aus öknomischer Perspektive ("The Derivation of Royalty Rates from an Economic Perspective") in the June 2014 issue of Mitteilungen der deutschen Patentanwälten (pp. 262-66).  Here is the abstract:

In third-party licensing practice the licensing parties often orient themselves towards the licensee's expected future profits and split this between themselves within the framework of license negotiations.  This policy is economically sensible.  The derivation of reasonable royalty rates should be based on business analysis.

(According to footnote *, the article is a slightly modified version of an article originally published in Betriebs Berater 2013, 2027-29.)  The author argues that a 25-33% division of expected profits from the use of a patent, converted into a running royalty based on a percentage of turnover, can be a useful guideline--not a hard and fast rule, as rejected in the Federal Circuit's 2011 Uniloc decision--taking into account all other relevant considerations such as the parties' preferences for risk-sharing, the expected contribution of other patents or trademarks to the product's profitability, and so on.  The author cites a 1972 work by Knoppe, Die Besteuerung der Lizenz- und Know-how-Verträge, throughout as approving such an approach. 

An English-language translation of Dr. Nestler's Betriebs-Berater article is available here.

In response, Mr. Hellebrand published Ableitung von angemessenen Lizenzsätzen aus öknomischer Perspektive?  Eine Erwiderung ("Derivation of Royalty Rates from an Economic Perspective?  A Response") in the November issue of Mitteilungen der deutschen Patentanwälten (pp. 494-97).  Here is the abstract (as above, in my translation from the German):

Market-standard royalty rates delineate the freedom to set license fees within the competitive environment of a market for technical products in a manner that is more accurate and more reflective of market realities than does a profit split of the EBIT (earnings before interest and taxes) of a single licensee, even when the latter is refined vis-a-vis the Knoppe [rule-of-thumb] formula by the licensing firm's analysis for the planned use.

As suggested by the abstract, Dr. Hellenbrand believes that market-standard rates are more likely to accurately reflect the value of the technology, and to be more administrable in practice.

Preliminary Injunctions in China

Jiang Liwei, Judge of the Beijing Third Intermediate People's Court, has published an article titled (in the English-language translation by Yuan Renhui) Preliminary Injunction: The New Favorable of IP Litigation, in the July-August 2014 issue of China Intellectual Property Magazine.  The article can be accessed online here.  Judge Jiang discusses a recent conference sponsored by the Beijing Third Intermediate People's Court titled "Top Seminar on IP Preliminary Injunction," at which several Chinese judges and academics presented their views on a variety of topics, including (1) whether there is a difference in the legal standard for granting a preliminary injunction that is requested before the filing of an action for infringement, and an "interlocutory" injunction that (I take it) is requested after the filing of an action; (2) what sort of factors are relevant to evaluating whether the patent owner faces irreparable harm; (3) whether the patentee should have to prove, by a preponderance of evidence, a likelihood of success on the merits or only a "susbtantial dispute"; (4) whether "there should be a comprehensive consideration of likelihood of success, balance of interest, security and other factors," such that "one factor can make up the lack of the other factor"; and (5) what standards should govern claims for damages for wrongly issued preliminary injunctions, and whether such claims may be brought by third parties who are affected by the injunction as well as by the infringement defendant.  

It's an interesting and informative paper on the differing views on these issues.  I'm particularly interested in seeing how Chinese law develops on claims for damages for wrongly issued injunctions, a topic that I have discussed on this blog a few times before (see here and here).  I also found interesting the suggestion that courts may grant preliminary injunctions "[w]here the patentee does not exploit the patent, but manufactures competing products" (p.25), a topic Erik Hovenkamp and I have discussed in a recent paper.  I would note a couple of areas of disagreement, however, with some statements the article makes about European law.  In particular, the discussion of whether China should permit the use of protective writs (as in Germany) (p.24) might seem to imply that patentees file these writs, when in fact it is prospective infringement defendants who do so (see my discussion here); and the discussion of likelihood of success arguably suggests that German courts do not consider this factor (p.26), when (according to my understanding) in practice they do consider whether the infringement is unambiguous and whether the patent's validity is adequately certain (see my book pp. 243-44 and my post here).  Finally, I would note that, contrary to the statement at p.25, post-eBay some U.S. courts have held that even in trademark infringement actions the plaintiff is not entitled to a presumption of irreparable harm (though to be fair, I believe there was only one such case on point when the article was published).  These quibbles aside, the paper is quite illuminating and well worth a read.  

For further discussion on this blog of preliminary injunctions in China, see here, here, here, here, here, and here, as well as my book (pp. 351-52).      

Nous sommes Charlie

En ces temps tristes, je tiens à exprimer ma solidarité avec les peuples français en soutien de la liberté d’expression.

Sidak on the Entire Market Value Rule

J. Gregory Sidak has published a paper titled The Proper Royalty Base for Patent Damages, 10 Journal of Competition Law & Economics 989-1037 (2014).  Here is a link to the paper, and here is the abstract:

How should a court determine the proper royalty base when calculating either reasonable-royalty damages for patent infringement or fair, reasonable, and nondiscriminatory (FRAND) royalties for infringement of, or licensing disputes over, standard-essential patents (SEPs)? This determination is particularly challenging in the context of a multi-component device, such as a smartphone. It is established patent jurisprudence that a reasonable royalty should reflect the terms of a hypothetical license resulting from a voluntary negotiation between a willing licensor and a willing licensee at the moment just before first infringement. In real-world patent negotiations, firms often calculate royalties with reference to the retail price of the downstream product. Therefore, using that downstream retail price as the royalty base is the most authentic assumption about the royalty base that a court could use for a hypothetical negotiation between a willing licensor and a willing licensee. Nonetheless, as a result of a recent series of confusing and contradictory opinions, the Federal Circuit in all but exceptional cases now decidedly favors using, for purposes of the hypothetical negotiation, a royalty base equivalent to the price of the infringing product’s “smallest salable patent-practicing component” instead of the “entire market value” of the product. In cases where the downstream product is the “smallest salable patent-practicing component” and unpatented features constitute a substantial proportion of the product, the Federal Circuit favors subtracting the value of these unpatented elements from the royalty base. This development in the law of the entire market value rule (EMVR) has perverse consequences that the Federal Circuit has yet to recognize. Using the price of the smallest salable patent-practicing component as the royalty base risks undercompensating the patent holder, because it ignores (1) the effects that the patented technology has on the value of the downstream product and (2) the value that synergies between complementary technologies create. A more complete economic approach would account for such complementarity effects by permitting the use of the retail price of the downstream product as the royalty base. The Federal Circuit’s choice of royalty base in its EMVR jurisprudence seems based on a theory that juries tend to overcompensate patent holders due to cognitive bias. However, the Federal Circuit fails to explain the logic and limits of its concern over cognitive bias. It therefore fails to justify its preference for the smallest salable patent-practicing component and risks undercompensating patent holders. Finally, I show that risk-averse firms should prefer structuring damages awards in a manner that reduces errors. This analysis of risk bearing indicates that, if a royalty with a low rate and high base is more accurate than one with a high rate and low base, courts should use the EMVR when awarding damages. The Federal Circuit’s jurisprudence on patent damages currently ignores this concern.

Some Recent Papers on Recovery of Attorneys' Fees and Costs in Patent Litigation

1.  Luke McDonagh and Christian Helmers have posted a paper on ssrn, originally published in Civil Justice Quarterly 32(3) (2013) pp. 369-84, titled Patent Litigation in England and Wales and the Issue-Based Approach to Costs.  Here is a link to the paper, and here is the abstract:

In England and Wales legal procedures with regard to patents are said to be both lengthy and costly. Nonetheless, at present there is little factual empirical evidence on procedural and costs issues in the UK. This makes it difficult to comprehend the state of patent litigation within the wider framework of civil litigation. The provision of analysis of both the processes undertaken and the costs accrued at the PHC is therefore of crucial importance. With this in mind, this article first explains the procedures for taking a patent case at the PHC and outlines the types of cases which typically occur, such as actions for infringement and challenges to patent validity. Secondly, in order to substantiate our analysis we examine a sample of 18 cases filed during 2000-2008 with regard to costs. We examine the discretionary, issue-based approach, the guidance given at the PHC to costs assessment judgment. and the way the courts deal with interim costs issues. Our study confirms that the costs of patent litigation are high, with the average cost of a full trial at the PHC, encompassing the costs of both sides, falling between £1 million and £6 million. We further explore the reasons for the high costs, including the strong disclosure requirement and the need for scientific experiments and expert testimony. Finally, we note that the perception of costs risks has the potential to influence the types of claims brought to the PHC, the rate of settlement of cases and the volume of cases. 

2. As noted recently on PatLit, Filip Fischmann, the Program Director of the Munich Intellectual Property Law Center (MIPLC) and Research Fellow of the Max Planck Institute for Innovation and Competition, has a paper coming out in the Journal of Intellectual Property Law & Policy titled Patent litigation and cost shifting in Europe: critical appraisal and proposal of alternative solutions.  Here is the abstract:

This article analyses different costs rules and practices regarding patent litigation in Europe, explains the functions played by cost-shifting provisions and proposes the introduction of a modulated two-way fee-shifting system, in order to enhance patent litigation.

Mr. Fischmann's paper focuses on the standards for recovering attorneys' fees in patent litigation under the Enforcement Directive, under English and German law, and under the UPC Agreement.  He proposes that the UPC Rules should "make use of costs scales, profiting from the German experience, and of an issue-based approach, benefiting from the English and Welsh practice"; and that "the UPC should reformulate the English and Welsh experience with certificates of contested validity and create a modulated two-way fee-shifting system," under which a patent owner who has successfully fended off an initial validity challenge would be able to recover a greater share of the costs it incurs in subsequent validity challenges.  Very interesting paper.
    
3. Randy Lipsitz, Aaron Frankel, and Hanna Seifert published a short paper in the October 8, 2014 issue of Bloomberg BNA Patent, Trademark & Copyright Law Daily (available here, behind a paywall), titled recent Supreme Court Decision Takes Us Back to the Future:  Attorney Fee Award Rate Increases in Patent Cases.  The authors samples 100 decisions from 2004 or earlier in which district courts considered whether to grant attorneys' fee awards under a discretionary totality-of-the-circumstances test; 100 cases from 2011-13, which applied the Brooks Furniture rule that the U.S. Supreme Court overruled in Octane Fitness; and all 40 post-Octane fee award cases published through September 18, 2014.  They report that fee awards were granted in 42% of such cases prior to 2004, in only 32% from 2011-13, and in 45% since Octane Fitness.  (Note, though, that the cases sampled are cases in which the court chose to publish a decision on whether to grant fees or not, which is surely a minority of cases.  Prior to Octane Fitness, I roughly estimated that about 5-7% of cases resulted in an award of attorneys' fees, based on others' published statistics (see here).  After Octane Fitness, the percentage may be higher, but the statute still only permits fees in "exceptional" cases.)  

4. More recently, Amanda L. Major and Jonathan Uffelman published A Practitioner's Guide to Post-Octane Fitness Decisions:  The New Landscape of Section 285 Attorney Fees in the December 10, 2014 issue of Bloomberg BNA Patent, Trademark & Copyright Law Daily (available here, behind a paywall). The authors examined the now-60 post-Octane Fitness decisions and have analyzed the relevant factors, including such matters as the relevance of pre-suit investigation, legally and factually unsupported arguments, and attempts to extract nuisance-value settlements, that may support an award. 

A Critique of the Federal Circuit's Recent Decision in Aqua Shield v. Inter Pool Cover Team

Today's guest post by Professor Norman Siebrasse of the University of New Brunswick Faculty of Law critiques the Federal Circuit's recent decision in Aqua Shield v. Inter Pool Cover Team, which I blogged about here. 

Professor Cotter and I have a recent paper posted on SSRN arguing that in assessing a reasonable royalty, the hypothetical negotiation should be assumed to take place ex ante, but with the full benefit of all ex post information. We call this the “contingent ex ante” approach to distinguish it from the “pure ex ante” approach, in which only ex ante information (with some exceptions) can be considered in the hypothetical negotiation. It was therefore disappointing to see the Federal Circuit embrace the pure ex ante approach in its recent decision in Aqua Shield v. Inter Pool Cover Team (available here, summary post here). Aqua Shield’s emphasis on the pure ex ante approach is puzzling as well as disappointing. On the facts, the only admissible evidence relevant to the royalty was ex post information, in particular, the infringer’s actual profits. Even under the pure ex ante approach, as was specifically affirmed in Aqua Shield, ex post information may be considered as evidence of what the parties would have believed ex ante. So, in this case, actual profits may be considered as evidence of expected profits. The two approaches only differ when there is conflicting evidence as to both expected and actual profits (or other relevant information). It is therefore unclear why the Federal Circuit emphasized the need to use the pure ex ante approach, given that it explicitly endorsed the use of ex post information. Moreover, even on the pure ex ante approach and even in light of the Federal Court’s decision, it is difficult to understand how the District Court erred.

Aqua Shield’s ‘160 patent relates to enclosures designed to cover pools or create sun rooms. The district court granted summary judgment against Inter Pool Cover Team (IPC) on infringement and validity. These judgments were not appealed (except regarding one of IPC’s models). The district court then conducted a two-day bench trial on remedies. In the original damages opinion, which I was unable to dig up, the district court held that Aqua Shield had failed to prove lost-profit damages. That was not appealed. The district court also refused a reasonable royalty, on the basis that there was not sufficient evidence to establish the reasonable royalty rate; while there was some evidence relevant to the Geogia-Pacific factors that indicated that the royalty should be adjusted upwards, there wasn’t sufficient evidence to determine the initial royalty rate that would then be adjusted. On a motion before the district court to alter the judgment, 2013 WL 6410975, the patentee argued that in determining a reasonable royalty the court should have considered (1) licensing negotiations that the parties conducted in 2009; (2) the inventor’s evidence; and (3) the infringer’s actual profits on infringing sales. The district court rejected the first two, on the basis that settlement negotiations conducted during litigation cannot be used to determine a reasonable royalty and the negotiations were not in any event confined to licensing of the invention at issue, and because the inventor’s evidence was not credible. These holdings were not challenged on appeal (Fed Cir slip op 10). The district court acknowledged that the infringer’s profit was admissible evidence which it wrongly failed to consider. Thus the only evidence on the reasonable royalty was the infringer’s actual profits. The district court went on to award reasonable royalty damages of 8% of the infringer’s net profits on infringing sales.

On appeal, the Federal Circuit emphasized what we have called the pure ex ante approach – “anticipated incremental profits under the hypothesized conditions are conceptually central to constraining the royalty negotiation” (slip op 10, emphasis added) – but it also acknowledged that “[e]vidence of the infringer’s actual profits generally is admissible as probative of his anticipated profits” (ibid). Thus the district court did not err in considering the evidence of actual profits.

The error, according to the Federal Circuit, lay in how that profit evidence was used:

[The district court] 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.

Under either the pure or contingent ex ante approach it is permissible to use the infringer’s anticipated incremental profits as a cap on the royalty, because the infringer’s maximum willingness to pay is set by the difference between the maximum profit available from the use of the invention and that available using the best non-infringing alternative: see eg Grain Processing 185 F.3d 1341, 1350-51 (Fed. Cir. 1999). It appears from the available opinions, namely those of the Federal Circuit and the district court’s opinion on reconsideration, there was no direct evidence at all of the anticipated profits; thus the actual profits were the only admissible evidence of the anticipated profits. It is true that the district court used the actual profits as a cap, but it did so expressly on the basis of the pure ex ante approach (slip op 4, 5):

Although a hypothetical license requires the royalty to be determined in light of anticipated profits when the infringement began, courts have held that evidence of subsequent actual profits is relevant to forming a judgment as to anticipated profits.

Considering [the benefits of the invention], while still allowing Defendants a profit on infringing sales, requires the Court to use its best ability to estimate what Defendants would have likely paid for the patented design.

The district court was evidently using the actual profits as evidence of the anticipated profits, and then using the anticipated profits as a cap on the royalty. This is entirely consistent with the pure ex ante approach.

Now, the infringer’s profits should not be used as a cap on the royalty when the infringer is a particularly inefficient producer. As the Federal Circuit explained:

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.

As noted, it is the infringer’s anticipated incremental profits – that is, the difference between its profits using the invention and using the best alternative – which sets the cap on the royalty. If the invention is better than the alternatives, the infringer’s incremental profits will be positive regardless of how inefficient the infringer might be, and a reasonable split of those incremental profits might well result in negative accounting profits. But on the facts, the Federal Circuit’s reference to an inefficient infringer is puzzling. There was no indication that the defendant in this case was particularly inefficient, and the district court explicitly considered the incremental value of the invention: “In a hypothetical negotiation, the Court finds Defendants would not have paid more [than 8% of net profits] for the license because they would have likely gone without the benefits of the '160 Patent and designed around it, as they have done now.” Again, it is difficult to see what is wrong with this analysis.

The Federal Circuit also held that “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” (original emphasis), explaining that “[t]he infringer’s selling price can be raised if necessary to accommodate a higher royalty rate.” Certainly, if an infringer is cutting prices to the bone, in part by avoiding paying a royalty, then positive accounting profits might well turn negative once a reasonable royalty is factored in. It would be wrong to use the infringer’s accounting profits (as opposed to its incremental profits) as a cap in such circumstances. The Federal Circuit stated that “On the record before us, we conclude that the district court committed [this error]” (slip op 11). Again, this is a puzzling statement. It is true, as mentioned above, that the district court allowed the defendants a profit on infringing sales, and this was evidently accounting profits, but the actual royalty was only 8% of net profits. An 8% royalty isn't close enough to the entire profit for the question of whether the district court wrongly thought it was bound to stay under 100% to be at issue. This contrasts with, for example, Golight, Inc. v. Wal-Mart Stores, Inc., 355 F.3d 1327, 1338 (Fed.Cir.2004), in which the Federal Circuit rejected the infringer’s complaint that the reasonable royalty awarded by the district court was unreasonable as a matter of law because it would have resulted in the infringer selling the product below cost. More importantly, the district court never invoked the infringer’s profits as a cap. While it did refer to the need to allow the defendants a profit on infringing sales, which may indeed be an error in some circumstances, as we have seen the court expressly held that if the royalty had been any higher the defendants “would have likely gone without the benefits of the '160 Patent and designed around it, as they have done now.” In other words, the cap is not the infringer’s accounting profits, but rather the incremental profit due to the invention.

Since I am writing without the benefit of the complete record, it may be that there is something else in the record which supports the Federal Circuit’s critique, but as it stands, the Federal Circuit’s decision is more puzzling than enlightening. If there is any error in the district court’s decision, it lay in using accounting profits rather than incremental profits as a cap on the royalty. That would be an error on the contingent ex ante approach just as much as on the pure ex ante approach. Consequently, while Aqua Shield explicitly embraces the pure ex ante approach, it is not particularly strong authority for that approach, as the holding on that point is purely dicta. When the only evidence is ex post evidence, as in this case, the contingent and pure ex ante approaches will come to the same conclusion, whatever other errors the court below might (or might not) have made.