Implicit in such reliance on but-for benchmarks is an often-unstated assumption: that the plaintiff brings the necessary assets and capabilities to the market to have achieved the forecast sales. The economic activity at issue in business litigation involves the efficient deployment of resources to generate profits; therefore, the first question that might be asked in assessing a claim of lost sales is whether the plaintiff would have been able to deploy the resources necessary to achieve the projected level of sales.
The question is intended to ground an analysis of lost sales in reality. A plumber injured in an accident cannot lay claim to the earnings of a surgeon, because the plumber held little hope of performing heart bypasses with or without the injuries sustained in the accident. Similarly, when a company claims lost sales, the case must be made that the firm would have been able and would have had the capacity to procure, manufacture, market, sell, and finance the products or services necessary to generate those expected sales while generating a profit on these activities.
While the capacity does not have to be present at the time of the alleged bad acts, it does have to be obtainable in time for the lost sales to have been made. In addition, it has to be reasonable for the firm to have made the required investments to generate the expected lost sales, and the costs of obtaining the capacity must be accounted for when computing the amount of lost profits. Without such foundation, the case for lost sales may be undermined.
In basic terms, one cannot assume success for the plaintiff in the but-for world. It is axiomatic that to establish lost sales, the sales must have been lost. If the sales would not have been obtained anyway, a claim for lost sales will not succeed.
Credibly establishing and calculating lost sales requires experts to consider the capabilities of the plaintiff, no matter the legal context of the case. The economic and legal strategy considerations in intellectual property (IP) matters, however, will differ from those found in breach of contract or antitrust cases. In this article, we contrast the legal and economic environment for IP matters with these other areas of the law, and discuss the factors that may be considered when deciding whether to pursue lost sales—which requires demonstrating the ability to achieve the claimed sales—or to seek other forms of relief.
Among various legal arenas, the question of whether a firm could have achieved lost sales is most explicitly contemplated in damages associated with patent infringement. Within patent claims, there are generally two paths to damages: lost profits or a reasonable royalty.
Supporting a reasonable royalty—which is often measured based on a hypothetical negotiation between the patentee and an allegedly infringing party—may require fewer assumptions than illustrating that the firm had the ability to exploit the patent directly. Whether a firm has the ability to bring a patent to market or has the capacity to achieve sales is generally relevant only to the extent that this condition might have affected the outcome of the negotiation. Most of the factors that guide the hypothetical negotiation, set forth in Georgia-Pacific Corp. v. United States Plywood Corp.,1 do not focus on the actual status of the parties in the market—the negotiation being hypothetical after all, in some sense the parties are hypothetical as well. Nevertheless, in such a negotiation, the patent holder’s ability to produce and sell the patented product may be one of the factors that influences the outcome of the negotiation.
To succeed on a lost profits claim, however, a patent owner must prove the four factors described in Panduit Corp. v. Stahlin Brothers Fibre Works, Inc.:
- demand for the patented product;
- the absence of acceptable noninfringing substitutes;
- the manufacturing and marketing capability to exploit the demand; and
- the profit that would have been made absent the infringing conduct.2
The third factor calls for an explicit consideration of a firm’s capacity to meet demand.3
Of course, a nonpracticing patent holder can still participate in a hypothetical negotiation and earn a royalty consistent with the royalties earned on other comparable patents. But that same nonpracticing patent holder would typically be unable to claim lost profits, for as the Federal Circuit has noted, “Normally, if the patentee is not selling a product, by definition there can be no lost profits.”4
The logic again calls the third Panduit factor into play. Even if a patentee is selling a product, there can also be no lost profits if it could not have made more units of it profitably, or profits may be limited if only so many additional units could have been made at the existing capacity. Although in Hebert v. Lisle Corp., the Federal Circuit lowered the hurdle slightly when it found that “it would be incorrect to bar a patentee who is not yet manufacturing the product from proving that its actual damages were larger than a reasonable royalty,”5 it still maintained that “the burden on a patentee who has not begun to manufacture the patented product is commensurately heavy” and reminded us that “[d]amage awards cannot be based upon speculation or optimism, but must be established by evidence.”6
More recently, the Federal Circuit has held that a patent holder can claim lost profits even for products that do not include the patented technology. In Poly-America, L.P. v. GSE Lining Technology, Inc., the court held that “the patentee needs to have been selling some item, the profits of which have been lost due to infringing sales, in order to claim damages consisting of lost profits.”7 By this reasoning, lost profits can be experienced because infringing conduct affects the sales of other products, even those unrelated to the products that practice the patent.
Trade Secret Damages
Trade secret cases are generally guided by a somewhat less consistent legal regime than patent law. Section 3(a) of the Uniform Trade Secrets Act (UTSA) states that “[d]amages can include both the actual loss caused by misappropriation and the unjust enrichment caused by misappropriation that is not taken into account in computing actual loss.”8 The language makes clear that these two forms of damages cannot be duplicative.
The opportunity for a plaintiff to claim either lost profits or disgorgement of the defendant’s unjust enrichment—but not both—makes the question of the plaintiff’s capacity somewhat less relevant. In an unjust enrichment claim, the plaintiff’s burden is to show only the defendant’s revenues attributable to the trade secret. It is thus the defendant’s burden, rather than the plaintiff’s, to identify deductible costs and to apportion profits to factors other than the alleged infringement—for example, to the characteristics of its own product and sales channel, which may considerably reduce an award of the defendant’s profits.
Because lost profits can be more difficult (and more costly) to measure, plaintiffs in trade secret cases often choose to pursue recovery based on unjust enrichment instead, especially if the plaintiff lacks the ability to replicate the defendant’s sales.9 Plaintiffs must contend with the question of capacity only in cases where the plaintiff claims (1) lost profits on sales that a defendant did not also make, or (2) a level of profit higher than that enjoyed by the defendant.
Copyright, Trademark, and Other IP Damages
The Copyright Act allows for statutory penalties for infringement of copyrighted works, and these are often the basis for a damages claim.10 In the alternative, as in trade secret cases, a plaintiff can recover its actual losses resulting from infringement or the profits of the infringer.11 Courts are required, however, to distinguish between the two; a plaintiff cannot recover both its own profits from a lost sale and the profits the defendant earned on that same sale.12
Here again, the option to pursue a recovery based on unjust enrichment, which eases the burden of proof on the plaintiff, makes the question of capacity somewhat less relevant. Lost profits are perhaps more relevant in copyright matters and more likely to be claimed in situations where the copyright is assigned to a certain feature of the product at issue, as may occur, for example, in the case of software or a specific product design.13 The issue of sufficient capacity may also be less relevant due to the nature of products that may be involved in copyright litigation (e.g., software, books, music, or other performing arts), where the marginal costs of additional production can often approach zero.
However, lost profits may make an appearance in other aspects of a copyright claim. Plaintiffs seeking injunctive relief, for example, are required to demonstrate that the infringement caused or causes “irreparable” harm and that there is no legal remedy available to compensate for the injury.14 In this context, the ability of a plaintiff to have achieved sales and profits in the absence of the infringement may indicate whether any harm is significant enough to warrant injunctive relief.
There is, of course, a difference between calculating damages to a plaintiff and estimating the harm of an infringement to a copyrighted work. However, valuing a copyrighted work may ultimately involve estimating the present value of cash flows associated with that work, which draws on an analysis of profits that would accrue to the holder of the copyright.
Notably, where injunctive relief is sought, defendants may argue that damages can be quantified and therefore can be remedied. On the other hand, plaintiffs may argue that the absence of sufficient ability to make sales and profits confounds efforts to quantify harm, and therefore injunctive relief is the more appropriate remedy. Here, plaintiffs would need to take care not to confuse the inability to estimate harm with the absence of harm. That is, if the inability of a plaintiff to make sales and profits is cited as the reason why damages cannot be quantified, one might reasonably ask whether there are any damages in the first place.
Similarly, courts have held that “[s]tatutory damages should bear some relationship to the actual damages suffered.”15 A demonstration of the plaintiff’s ability to achieve sales may therefore be a necessary element of a plaintiff’s case (or, conversely, an element of the defense’s rebuttal), even in instances where the plaintiff seeks statutory damages rather than lost profits.
The Lanham Act, which governs trademark infringement and dilution, also permits an infringed party to claim lost profits.16 The logic of the Panduit factors applies in these claims as well; plaintiffs should be able to demonstrate demand motivated by or associated with the trademark and that, in the absence of the infringement or dilution, the plaintiff had the ability to meet such demand. As with copyright and trade secrets, however, a recovery based on an unjust enrichment claim may be more demonstrable, perhaps in part because the first Panduit factor (demand for the products at issue) may be difficult to establish, as well as because of the other factors described above.
In breach of contract and tortious interference cases, the remedies available to a plaintiff are intended, among other things, to make the plaintiff whole for a contract that was either breached or interfered with by a defendant. Depending on the legal theory of the case, such remedies may include expectation damages, reliance damages, or restitution. To the extent sales were expected to flow to the plaintiff under the contract at issue, determining lost sales may be relevant for any of these damages theories. In such instances, it may be important to demonstrate that the plaintiff had the ability to achieve those sales, just as in other business litigation.
The greater challenge in such cases may rest with defendants. A plaintiff firm that enters into a contract in good faith presumably has some expectation with respect to its ability to achieve desired sales and, ultimately, profits; the defendant may be required to demonstrate that this belief was misguided, despite having entered into a contract with the plaintiff in the first place. For example, if the defendant agrees to sell 10,000 widgets to the plaintiff and accepts payment terms from that plaintiff, it may be difficult for the defendant to claim that the plaintiff had no hope of reselling the widgets profitably.
In cases involving joint ventures, where one of the parties claims a breach of the agreement forming the venture, the defendant may argue that it terminated the agreement based on newly acquired information that led it to believe that the plaintiff would not have been able to provide the necessary assets or capabilities required under the joint venture agreement, or that the planned business of the joint venture was no longer viable. Such a claim by the defendant may then also be relevant in determining any damages, as the plaintiff’s inability to contribute the agreed-upon assets and capabilities would likely have resulted in lower-than-forecast sales.
That said, courts have held that any lost sales claims regarding contractual relationships must be “fairly within the contemplation of the parties to the contract at the time” the contract was signed.17 In this sense, when lost sales are claimed beyond the scope contemplated in the contractual terms, defendants may more legitimately question whether a plaintiff could have achieved the claimed lost sales.
With regard to antitrust cases, the D.C. Circuit has observed that “[t]he computation of damages in antitrust cases invariably has a certain Alice-in-Wonderland quality to it.”18 The “looking glass” through which courts must consider antitrust damages claims is a market allegedly distorted by anticompetitive conduct. Such a market does not form a good basis for assessing damages claims. Therefore, in contrast with the law on patent damages, antitrust law tends to be less limiting about the nature of a claim that may include lost sales.
Section 4 of the Clayton Antitrust Act allows private parties injured by conduct forbidden under antitrust law to sue and “recover threefold the damages by him sustained, and the cost of suit, including a reasonable attorney’s fee.”19 In cases of alleged price fixing (i.e., violations of section 1 of the Sherman Antitrust Act), private plaintiffs have chosen to pursue damages claims based on overcharges, rather than lost sales.20 Lost sales claims may be more common in cases of exclusionary conduct (e.g., illegal bundling/tying, licensing, or pricing policies).
In antitrust cases, claimed lost sales may refer to the third key issue previously mentioned: allegations that the exclusionary conduct has impaired the ability of a nascent competitor to compete. Consequently, these types of conduct significantly harm not only a firm’s ability to have achieved the sales that it claims but also its ability to demonstrate that it could have made those sales.
If held to a strict interpretation of the standard as suggested by the Panduit court, there would be hardly any enforcement of the antitrust law by private plaintiffs seeking recovery of lost sales. As Professor Hovenkamp has noted, the antitrust law has tended to favor damages concepts that facilitate enforcement and deterrence, even if these concepts are ill-suited to empirical analysis and ultimately irrelevant to the question of whether the conduct deterred by a penalty or damages award was in fact economically inefficient.21
Courts have given wider latitude to antitrust plaintiffs to make claims of lost sales, even where it may have been difficult to establish that the plaintiff had the ability to achieve those sales, because conditions in the but-for world—including the capabilities of the plaintiff itself—are so difficult to know. As the court noted in Terrell v. Household Goods Carriers’ Bureau: “To deny recovery to a businessman who has struggled to establish a business in the face of wrongful conduct by a competitor simply because he never managed to escape from the quicksand of red ink to the dry land of profitable enterprise would make a mockery of the private antitrust remedy.”22
That said, courts have balanced what is ultimately a public policy concern with a recognition that undue speculation should not lead to unrealistic estimates of lost sales. As Judge Posner noted, in antitrust damages cases “there is also a big problem of quantifying lost hopes.”23 Therefore, while plaintiffs may not be limited in their damages claims to existing capabilities and assets, they have an obligation to demonstrate that these capabilities and assets could—and perhaps more importantly would—have been acquired but for the defendant’s conduct. In this respect, the standard is no different for antitrust plaintiffs than for other plaintiffs; plaintiffs must show that, absent the defendant’s conduct, they would have been able to achieve the lost sales they claim. The difference is that in an antitrust case, the defendant’s conduct may have distorted the market to such an extent that making that demonstration is more difficult.24
Legal Framework: Conclusion
The way business or economic experts and lawyers consider the question of whether a plaintiff could have achieved lost sales can depend on the legal framework and type of case. Where damages analyses are required to specifically address this question, an effort should be made to ground damages analyses in reality and ensure that the plaintiff’s lost sales are consistent with that reality. In addition to showing that sales could have been made by someone but for the conduct at issue, the plaintiff must also demonstrate that it, itself, would have had the resources necessary to overcome any constraints to its capacity to achieve those sales, while providing a reasonable estimate of the costs necessary to do so.
The nature of the case may make these issues less relevant, as in cases where unjust enrichment may be claimed in lieu of lost profits, or as in a contractual dispute, where the scope of the legal dispute circumscribes the damages claim.
In antitrust specifically (as well as in other areas of the law), damages are both a means to compensate losses by the plaintiff and to create incentives for more optimal market outcomes. In such cases, damages analyses must consider both whether a plaintiff would have had the capacity to achieve lost sales given actual assets and performance and whether the conduct at issue is responsible for any impairment of that ability.
1. 318 F. Supp. 1116, 1119–20 (S.D.N.Y. 1970), modified and aff’d, 446 F.2d 295 (2d Cir. 1971).
2. 575 F.2d 1152, 1156 (6th Cir. 1978).
3. Id. Note that the second factor, lack of noninfringing substitutes, has been modified over time. See, for example, State Industries, Inc. v. Mor-Flo Industries, Inc., 883 F.2d 1573 (Fed. Cir. 1989), and its progeny. This modification does not affect the issues raised in this article.
4. Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1548 (Fed. Cir. 1995) (en banc).
5. 99 F.3d 1109, 1119–20 (Fed. Cir. 1996); see also King Instruments Corp. v. Perego, 65 F.3d 941, 949–51 (Fed. Cir. 1995).
6. Herbert, 99 F.3d at 1119–20.
7. 383 F.3d 1303, 1311 (Fed. Cir. 2004).
8. Unif. Trade Secrets Act § 3(a) (Unif. Law Comm’n 1985) (emphasis added). Almost all of the 50 states have adopted the UTSA to some degree, and while there is some state-to-state variation in the law on damages analyses for trade secrets, most of the variation concerns the application of reasonable royalties.
9. In some districts, the ability to claim unjust enrichment may be limited to cases in which the infringement was willful.
10. 17 U.S.C. § 504(c).
11. Id. § 502(b).
12. See Taylor v. Meirick, 712 F.2d 1112 (7th Cir. 1983).
13. See, e.g., Stevens Linen Assocs., Inc. v. Mastercraft Corp., 656 F.2d 11 (2d Cir. 1981); Mfrs. Techs., Inc. v. CAMS, Inc., 706 F. Supp. 984 (D. Conn. 1989).
14. John Leubsdorf, The Standard for Preliminary Injunctions, 91 Harv. L. Rev. 525 (1978); see also eBay Inc. v. MercExchange, LLC, 547 U.S. 388 (2006).
15. Peer Int’l Corp. v. Luna Records, Inc., 887 F. Supp. 560, 568 (S.D.N.Y. 1995).
16. 15 U.S.C. § 1117(a).
17. Kenford Co. v. County of Erie, 67 N.Y.2d 257, 261 (1986).
18. Smith v. Pro Football, Inc., 593 F.2d 1173, 1189 (D.C. Cir. 1979).
19. 15 U.S.C. § 15. The breadth of the statute is discussed effectively by Jonathan M. Jacobson & Tracy Greer, Twenty-One Years of Antitrust Injury: Down the Alley with Brunswick v. Pueblo Bowl-O-Mat, 66 Antitrust L.J. 273 (1998).
20. Given the favorable treatment in federal court that direct purchasers receive under Illinois Brick and Hanover Shoe, this is not surprising. If plaintiffs were required to wrestle with the question of whether their prices changed to pass on any elevated prices to customers, lost profits claims would be the natural alternative. But in some markets, pass-through may be high and demand elasticity such that some private plaintiffs may have little if any lost profit.
21. See Herbert Hovenkamp, A Primer on Antitrust Damages (Univ. of Iowa Legal Studies Research Paper 2011), https://papers.ssrn.com/abstract=1685919.
22. 494 F.2d 16, 23 n.12 (5th Cir. 1974).
23. Grip-Pak, Inc. v. Illinois Tool Works, Inc., 694 F.2d 466, 475 (7th Cir. 1982).
24. In this sense, the trebling of damages under the Clayton Act may imprecisely balance the effect of a higher standard of proof imposed by the defendant’s conduct in such cases, though clearly trebling was meant to address the incentives of the defendant, rather than the plaintiff. See Hovenkamp, supra note 21, at 21.