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December 2024/January 2025: IP Portfolio Management

Lost Profits Indicators in Reasonable Royalty Analyses: Consideration of Apportionment Reemphasized in Wirtgen

Alexander Lane Clemons, Sonja Popovich, and Liam Howe

Summary

  • The entire market value rule allows for the recovery of damages based on the value of an entire product if the patented feature is the sole driver of consumer demand.
  • When claims relate to a multi-component product, damages must be apportioned to account for noninfringing elements.
  • The Federal Circuit has approved of various apportionment methodologies when considering lost profits indicators in a reasonable royalty analysis.
Lost Profits Indicators in Reasonable Royalty Analyses: Consideration of Apportionment Reemphasized in Wirtgen
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While lost profits damages and reasonable royalty damages are separate and distinct forms of recovery for claims of patent infringement, the U.S. Court of Appeals for the Federal Circuit (CAFC) and various district courts have issued opinions allowing damages experts to consider a plaintiff’s lost profits in the context of a reasonable royalty calculation. As recent case law illustrates, however, there may be limits to such an analysis, and existing principles of apportionment may still apply. For example, in Wirtgen America, Inc. v. Caterpillar, Inc., Judge Joshua D. Wolson excluded the damages analysis of the plaintiff’s damages expert for her “use of unapportioned lost profits” in her reasonable royalty analysis. When considered in light of other case law on the subject, Wirtgen provides helpful guidance to parties, counsel, and experts seeking to incorporate lost profits indicators into a reasonable royalty analysis, while still accounting for apportionment.

Apportionment in Wirtgen

In Wirtgen, the district court initially excluded the plaintiff’s damages expert’s opinion for failure “to apportion her damages to account for non-infringing elements” of the accused products. However, the court ultimately allowed the expert to testify at trial, following the issuance of a supplemental report revising her opinions “to take care of the apportionment issue.”

In calculating her original reasonable royalty, the damages expert considered a hypothetical negotiation between Wirtgen and Caterpillar, in which Wirtgen “would be reluctant to license to Caterpillar, even under very favorable license terms.” Describing the expert’s reasonable royalty analysis, the court stated:

Nevertheless, using a willing licensor/willing licensee framework, [the damages expert] estimated the highest amount that would ensure Caterpillar found the agreement profitable (otherwise known as Caterpillar’s maximum willingness to pay or “MWP”) and the lowest amount that would ensure Wirtgen found the agreement profitable (Wirtgen’s minimum willingness to accept or “MWA”). [The damages expert] defines Caterpillar’s MWP as “the anticipated incremental profits earned from practicing the Asserted Patents,” and Wirtgen’s MWA as “the profits it anticipates to lose should Caterpillar practice the Asserted Patents.” The difference between those [(]Wirtgen’s MWA and Caterpillar’s MWP) equals the “joint surplus value.”

The damages expert then “apportion[ed] the joint surplus value using an apportionment rate based on a count of family-level forward patent citations [and] split[] the apportioned joint surplus value between the parties using the Rubenstein bargaining model.” The final damages amount was calculated “by adding Wirtgen’s split of the apportioned joint surplus value to Wirtgen’s MWA.” According to the court, Wirtgen’s MWA accounted for “roughly 95%” of the damages calculated. The expert claimed that “the method for determining Wirtgen’s MWA would not change depending on which patents the jury finds Caterpillar infringed” and “acknowledged that she ‘did not conduct any patent-by-patent apportionment’ with respect to her calculation of the MWA.” The court explained that the damages expert “apportioned only the joint surplus value. That is, she didn’t apportion Wirtgen’s MWA/lost profits.”

Based on various CAFC opinions, the court explained that “[a]pportionment requires that ‘a patentee must take care to seek only those damages attributable to the infringing features’” and that “[t]he entire market value rule ‘is a narrow exception’ to the rule of apportionment.” Citing the CAFC’s opinion in Asetek Danmark A/S v. CMI USA Inc., the court stated that “[i]n her reasonable royalty calculation, [the damages expert] was permitted to ‘consider the profits on sales [Wirtgen] might lose as a result of granting a license.’” The court further indicated that such a “framework might be particularly relevant in a case like this one where the licensor would have been reluctant to make a deal.” However, the court cautioned that such a lost profits figure must still “isolate the value of the allegedly infringing features from the value of all other features.”

To satisfy this requirement, the court explained that the damages expert could “invoke the entire market value rule,” apply methodologies that “build in apportionment” such as “us[ing] the Panduit factors to arrive at her lost profits number” or relying on “comparable licenses,” or “find another adequate way to apportion her damage award in light of the facts of this case.” Instead, the court found that the damages expert “attempt[ed] to meet that requirement in her analysis of Georgia-Pacific’s Factor 13, but [it was] inadequate,” as she merely “mentioned apportionment” without a “more fulsome analysis.”

The court noted that “[a] failure to apportion goes to admissibility, not weight,” and found that “[b]ecause she fails to apportion to ensure that Wirtgen would receive only the benefit of its patented technologies in her damages analysis, [the damages expert’s] analysis runs afoul of governing Federal Circuit precedent and requires exclusion.” In excluding the expert’s opinions, the court stated:

[Wirtgen’s damages expert] didn’t properly apportion her reasonable royalty, even though the law requires her to do so. In simplified terms, her royalty payment sums two figures: Wirtgen’s MWA; and the joint surplus value. But [the damages expert] apportioned only the joint surplus value. That is, she didn’t apportion Wirtgen’s MWA/lost profits. In other words, [the damages expert] premises Wirtgen’s lost profits on sales of entire machines and not the value that a specific patent added to that machine. Thus, she sets a whopping 95% of her damages figure in a way that includes the value of all the other features in the machines. Because [the damages expert] doesn’t invoke the entire market value rule, that’s impermissible.

The court further explained:

[I]n constructing the hypothetical negotiation, [Wirtgen’s damages expert] assumed that Wirtgen wouldn’t enter into a license with Caterpillar unless it received at least all of the profits it would lose from lost machine sales. That assumption holds true regardless of the value of those technologies or circumstances that might have made Caterpillar less willing to license some patents than others. Federal Circuit law does not allow [the damages expert] to make that assumption, however. She had to apportion her damages to account for non-infringing elements of the [products] at issue. Her failure to do so means that I must exclude her damages analysis.

Following the court’s order excluding her testimony, the damages expert issued a supplemental damages report in which she “removed Wirtgen’s minimum willingness to accept and applied the calculations from the previously disclosed forward patent-citation analysis and Rubenstein bargaining model to the entirety of the Accused Profits.” The court found that the revised “analysis properly consider[ed] the patented features of the machines” and “[took] care of the apportionment issue.”

According to Caterpillar’s motions to exclude, the damages expert’s initial analysis resulted in a royalty range from $56.1 million to $72.3 million, while the revised analysis resulted in a royalty range from $10.1 million to $69.5 million. Ultimately, at trial, the jury determined that Caterpillar infringed five of six patents asserted by Wirtgen and awarded $13.0 million in damages.

Lost Profits Indicators in Reasonable Royalty Analyses

As noted by Judge Wolson in Wirtgen, the CAFC has previously approved of considering lost profits in determining reasonable royalty damages. Nearly 30 years ago, the CAFC stated in Rite-Hite Corp. v. Kelley Co. that it was “not unreasonable for the district court to find that an unwilling patentee would only license for one-half its expected lost profits and that such an amount was a reasonable royalty.” The court in Rite-Hite further stated that “the fact that the award was based on and was a significant portion of the patentee’s profits also does not make the award unreasonable.”

Opponents of such an approach have claimed that it “circumvent[s] the requirement, applicable when lost-profits damages are sought, that a patent owner prove that it would have made the infringer’s sales ‘but for’ the infringement—a requirement not applicable to reasonable-royalty damages.” However, in Asetek, the CAFC explained that such objections lack merit, stating:

As we have recognized, a patent owner participating in a hypothetical negotiation would consider the profits on sales it might lose as a result of granting a license. Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1554–55 (Fed. Cir. 1995) (en banc). The fact that a royalty calculation relies in part on the patent owner’s per-unit profits does “not make it an unreasonable award.” Id. at 1555. We have explained that a patent owner would be “unlikely” to be “interested in” accepting a royalty rate lower than its profit margin on the patented products. See Mitutoyo Corp. v. Cent. Purchasing, LLC, 499 F.3d 1284, 1292 (Fed. Cir. 2007) (stating that the patent owner would be “unlikely [to] have been interested in less than a 29.2% [reasonable-royalty] rate,” equal to the patent owner’s profit margin). Negotiating for a per-unit payment equal to its per-unit profit can be a logical approach for a patent owner that is uncertain of how many sales might be lost by granting the license at issue or is just using its own experience to place a value on the right to use the technology at issue.

The court in Asetek noted that “[a] hypothetical-negotiation analysis for a royalty considers not only the patent owner’s interests, but also the other side of the negotiation table under the particular conditions of the hypothetical negotiation.” However, it did not explicitly discuss apportionment.

In a more recent decision, the CAFC considered a damages methodology similar to that employed by the damages expert in Wirtgen, which considered the defendant’s incremental profits and the plaintiff’s lost profits. In Bayer HealthCare LLC v. Baxalta Inc., the CAFC explained:

[The plaintiff’s damages expert’s] report included “substantial analyses to determine ‘end points of the bargaining range for the hypothetical negotiation,’” including “deriv[ing] a maximum royalty rate from the incremental profits [the defendant] would expect to earn from [the accused product], and a minimum royalty rate from the profits [the plaintiff] would expect to lose by granting a license to [the defendant].” [The expert’s] testimony further demonstrates that he considered and discussed the appropriate Georgia-Pacific factors at length in determining the range of reasonable royalties[.]

In Bayer, the CAFC found that “[t]he district court properly exercised its discretion in allowing Bayer to ask the jury to select a rate between the range presented.” However, as in Asetek, it did not explicitly discuss apportionment.

Based on Rite-Hite, Asetek, and Bayer, it seems clear that lost profits indicators may be considered in the context of a reasonable royalty analysis. What is less clear, at least from these three cases, is how principles of apportionment apply to such an analysis.

Accounting for Apportionment

Apportionment has long been a key consideration in patent damages, with roots dating back to the 1884 U.S. Supreme Court case Garretson v. Clark. As the Court explained in Garretson:

[The patentee] must in every case give evidence tending to separate or apportion the defendant’s profits and the patentee’s damages between the patented feature and the unpatented features, and such evidence must be reliable and tangible, and not conjectural or speculative; or he must show, by equally reliable and satisfactory evidence, that the profits and damages are to be calculated on the whole machine, for the reason that the entire value of the whole machine, as a marketable article, is properly and legally attributable to the patented feature.

More recent cases from the CAFC provide further guidance regarding apportionment. In VirnetX, Inc. v. Cisco Systems, Inc., the court explained that “when claims are drawn to an individual component of a multi-component product, it is the exception, not the rule, that damages may be based upon the value of the multi-component product.” The court went on to state that it had “recently reaffirmed that ‘[a] patentee may assess damages based on the entire market value of the accused product only where the patented feature creates the basis for customer demand or substantially creates the value of the component parts.’ In the absence of such a showing, principles of apportionment apply.” This exception to apportionment is known as the entire market value rule.

As summarized in Commonwealth Scientific & Industrial Research Organisation v. Cisco Systems, Inc., “[u]nder the entire market value rule, if a party can prove that the patented invention drives demand for the accused end product, it can rely on the end product’s entire market value as the royalty base.” However, as the court explained in Ericsson, Inc. v. D-Link Systems, Inc., “where multi-component products are involved, the governing rule is that the ultimate combination of royalty base and royalty rate must reflect the value attributable to the infringing features of the product, and no more.” The court in Ericsson stated that “[t]he essential requirement is that the ultimate reasonable royalty award must be based on the incremental value that the patented invention adds to the end product.”

However, even where the entire market value rule is not met, apportionment can be built into a reasonable royalty analysis through the use of appropriate starting points. For example, in Vectura Ltd. v. GlaxoSmithKline LLC, the court stated that “when a sufficiently comparable license is used as the basis for determining the appropriate royalty, further apportionment may not necessarily be required.” As the Vectura court explained, “[t]hat is because a damages theory that is dependent on a comparable license (or a comparable negotiation) may in some cases have ‘built-in apportionment.’” The court further explained that “[b]uilt-in apportionment effectively assumes that the negotiators of a comparable license settled on a royalty rate and royalty base combination embodying the value of the asserted patent.” Therefore, “a party relying on a sufficiently comparable license can adopt the comparable license’s royalty rate and royalty base without further apportionment and without proving that the infringing feature was responsible for the entire market value of the accused product.”

Similarly, apportionment can be built into lost profits indicators as well. For example, in Mentor Graphics Corp. v. EVE-USA, Inc., the court found, on the facts of that case, that “satisfaction of the Panduit factors satisfies principles of apportionment.” In Mentor Graphics, the court explained that “Panduit’s requirement that patentees prove demand for the product as a whole and the absence of non-infringing alternatives ties lost profit damages to specific claim limitations and ensures that damages are commensurate with the value of the patented features.” The court further explained that “when the Panduit factors are met, they incorporate into their very analysis the value properly attributed to the patented feature.”

Based on the cases discussed above, while principles of apportionment should be considered in every case, the CAFC has provided examples of various patent damages analyses that do not require further apportionment or include built-in apportionment.

Lessons from Wirtgen

Wirtgen lays out one potential framework for applying principles of apportionment when considering lost profits indicators in a reasonable royalty analysis. The court suggests that where the entire market value rule applies, no apportionment is necessary; however, where this exception does not apply, the reasonable royalty analysis must apply methodologies that either build in apportionment (e.g., the Panduit factors or comparable licenses) or apply another apportionment methodology, based on the specific facts of the case. Given that Asetek and Bayer did not explicitly discuss apportionment, it is not clear whether the CAFC will ultimately adopt this specific framework. In any event, parties, counsel, and experts would be wise to apply principles of apportionment where facts dictate and consider the potentially nonexhaustive list of ways to account for apportionment that courts have highlighted.

For example, the Wirtgen opinion provides guidance as to how practitioners might consider applying principles of apportionment in a similar case before a court applying a similarframework. As a starting point, it is worth noting that Wirtgen’s damages expert appears to have acknowledged the need for apportionment in her analysis, at least to some extent, by apportioning her calculated “joint surplus value.” By apportioning one element of her reasonable royalty analysis, and not another, she may have implicitly signaled to the court that her analysis required apportionment, generally. Therefore, one potential alternative may have been for the damages expert to have simply applied the same apportionment to her MWA (lost profits) amount as she did to the “joint surplus value” amount. Although forward citation analyses and game theory bargaining models have not been universally accepted by courts in all cases, the Wirtgen court did consider the damages expert’s apportionment methodology to be acceptable there.

Additionally, the court’s ruling may have been different had the expert divided the asserted patents into subgroups, which may have lent themselves to different damages methodologies, including methodologies that may not have required additional apportionment for at least a subset of the patents. In its opinion, the court stated:

Around the time of the hypothetical negotiation, Caterpillar analyzed several of Wirtgen’s patents to determine how they impacted Caterpillar in the marketplace. For some, Caterpillar concluded that it had no workaround and its inability to provide the patented technology substantially harmed its market position. But for the ’309 Patent, Caterpillar determined that it could design a workaround in a few months and at a relatively low cost. By assuming that Wirtgen’s MWA would be its lost profits, and then setting that as a damages floor, [the damages expert] fails to account for the fact that the ’309 Patent—as one example—was less valuable to Caterpillar. Apportionment would have corrected that flaw.

This excerpt indicates that the specific facts of the case may have supported an entire market value rule analysis or a Panduit factors analysis for a subset of the patents, given their apparent value to Caterpillar in the marketplace. For the remaining patents, the damages expert could have considered alternative reasonable royalty methodologies, such as the cost approach. By dividing the asserted patents into subgroups and applying separate reasonable royalty methodologies to each subgroup, the damages expert perhaps could have protected the more commercially valuable patents from being subject to the same need for further apportionment the court identified for the less commercially valuable patents. Although it is often not necessary to perform reasonable royalty analyses patent-by-patent or subgroup-by-subgroup, such a strategy may have been useful on the specific facts of this or a similar case.

Furthermore, in Bayer, the CAFC approved of a methodology in which the damages expert calculated a reasonable royalty range, with the defendant’s expected incremental profits as a maximum and the plaintiff’s expected lost profits as a minimum, along with appropriate consideration of the Georgia-Pacific factors. Such a methodology may have been available to Wirtgen’s damages expert as well. The Wirtgen court also indicated that the damages expert should have found “another adequate way to apportion her damage award in light of the facts of this case,” leaving open the possibility that creative damages experts could identify other suitable methodologies that account for principles of apportionment.

While it is not yet clear whether the CAFC will ultimately adopt the framework expressed in the Wirtgen case, it serves as an important reminder to parties, counsel, and experts to consider how principles of apportionment may apply to the specific facts of each case.

©2024. Published in Landslide, Vol. 17, No. 2, December 2024/January 2025, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

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