Merges on Patent Damages

Rob Merges has posted on ssrn a draft of a very interesting paper, titled Two Patent-Related Harms, Two Remedies: Injury to Market and Uncompensated Input Use.  Here is a link, and here is the abstract:

            I argue that the two types of damages described in the Patent Act are more than a menu of compensatory options. They describe two distinct types of harm caused by patent infringement. Each comes with a distinctive cluster of remedies. Harm to Product Markets (HPM) is redressed by lost profit damages, and in most cases a permanent injunction against future infringement. This type of damages can be thought of as the mirror image of damages for violations of antitrust law. Antitrust cases are about illicit lack of competition: a wrongful reduction in the competitive state of a product market. Patent damages are about illicit competition: the presence of an unauthorized competitor (the infringer) wrongly increasing the level of competition in the market for the patented item. Odd as it may seem to students of microeconomics, HPM damages are all about giving compensation for interference with a virtuous, or at least statutorily-protected, monopolist.

 

            The other type of harm, Lost Licensing Opportunity (LLO), occurs when a patent owner is not a participant in the product market for products embodying the patented invention. The traditional remedy of a reasonable royalty is applied in these cases: the law in effect writes a hypothetical contract in which the patent owner licenses its patent to the infringer. Compensation takes the form of an estimate of the value the infringer gained by using the patent owner’s technology as an input. When the input adds real value, and the infringer who used it has at least general notice that the input is patented, the reasonable royalty measure of damages does much the same as HPM damages. The only difference is that damages in LLO cases are measured in markets for patent licensing, rather than for patented products.

 

            But not all LLO harm is truly equal. Not all involuntary conferral of benefits should be thought of as the equivalent of a market exchange. Restitution emerged as a distinct branch of equity to address just this issue. Restitution principles reflect the fact that sometimes a benefit is conferred not on a willing market participant, but on a recipient who never asked for the “benefit” and had no effective notice of it; would prefer not to have received it; and in some cases is the victim of strategic, opportunistic tactics that make “receipt” of the benefit unavoidable. One example from patent law is when a patent owner alters patent boundaries to capture some of the value of the recipient’s own contributions (“engineered encroachment”, as I refer to it). In most contemporary private law interactions, the law protects the innocent defendant by requiring fault or intent before liability is imposed. But lack of notice, and the good vs. bad faith of the patent owner, are irrelevant in patent law’s regime of strict liability for direct infringers. My proposal here is for courts to sort out the different types of LLO harm using traditional principles of restitutionary recovery. When a patented, intangible input (benefit) is used (received) by an infringer, patent courts should deploy the full spectrum of restitutionary doctrine in pursuit of interparty fairness under the facts of each infringement case. In extreme cases of “engineered encroachment”, for example, courts might deny any recovery for infringement.

I need to reread and think about some of the issues Professor Merges raises in the paper, but my initial reaction is that I agree with most of it.  I was struck by his description of lost profits as the mirror image of antitrust damages—which seems right to me, though I had never thought of it that way before.  And I agree with his discussion toward the end of the paper, where he talks about how historically patent doctrine was more flexible (less formalistic) than it is today, and arguably needs some more flexibility now.  One of his major points is that the law of restitution could provide a tool by which courts tailor (reduce) awards of reasonable royalties in cases in which the patentee is not an “idea factory” but rather a patent troll (especially one who acquires a pending application and amends the claims to cover after-arising products).

One part where I think some additional variants might be useful is where Merges discusses the following hypothetical:

            Patent Owner A, for example, sells truck docking devices for warehouses, retail stores, etc.; the devices keep trucks snug to the loading dock while fork lifts and loading hands unload the contents of a truck. Owner A made its reputation with its Good Old X model, the first and most popular truck docking unit. But A designed a more high-tech (and more expensive) docking unit, New Y, which A has positioned to succeed Good Old X in the market. In pursuit of this plan, A recently announced the discontinuance of the Good Old X model. Just after this announcement, a new competitor company, B, launched operations. B announced it would commence making a docking unit much like Good Old X. In response, A, which still holds several patents on various features of Good Old X, filed a patent infringement suit against B.

He argues that in such a case the patentee should be able to recover an injunction against B and some sort of reasonable royalty:

            Patent rights are no longer tied tightly to the patent owner’s implementation of their claimed invention. They now cover the right not to practice the invention: to use the patent right to foreclose anyone from entering the exclusionary zone, so as to increase the profitability of the product space adjacent to that zone. Patents also include the right to use one of the patent owners’ stockpiled technological options not to protect the owner’s own product, but to earn royalties on the products of a rival who infringes a patent on one of the patent owners’ “roads not taken”. All of these are examples of a patent on an intangible input being used by its owner to protect the owner’s market-based income stream. . . . Where a patent is used to prevent competition from one variant, so as to indirectly enhance profits on a high-profit variant preferred by the patent owning firm, the measure of restitutionary compensation could actually be higher than in the case of an overlooked “idea factory” patent. The premium – recognized in some actual cases – is justified by the situation. The owner would usually prefer not to license the relevant patent at all. The patent’s value in blocking competition may make it difficult to estimate what the owner would ask in royalties in a willing bargain with the infringer/licensee. The difficulty of putting a dollar value on a competition-blocking patent may support grant of an injunction against future harm. But as for past damages, the courts are left applying a “willing licensor-licensee” test to determine the royalty term in a patent license that the patent owner is being dragged into against their will and against their economic interests.

I generally agree with this analysis, though I would add the (perhaps obvious) point that if Patent Owner A has actually started selling New Y, it should recover its lost profit, if any, on lost sales of New Y; I think Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538 (Fed. Cir. 1995) (en banc), leads to that result, and Roger Blair and I have argued (Rethinking Patent Damages, 10 Tex. Intell. Prop. L.J. 1, 74-84 (2001)), that that probably is the correct outcome in such a case.  On the other hand, a variation in which I would be more skeptical of awarding an injunction—though I confess to being unsure exactly how to calculate damages—would be one like Trebro Mfg., Inc. v. FireFly Equip., LLC, 748 F.3d 1159 (Fed. Cir. 2014), where the patentee acquired (but didn’t use or license) a patent after having already entered the market with a different, unpatented product.  Erik Hovenkamp and I discussed that type of case in our article Anticompetitive Patent Injunctions, 100 Minn. L. Rev. 871 (2016), arguing that courts shouldn’t award an injunction, but leaving open the damages question.