May 01, 2017 Articles

Intellectual Property Damages: Using the Book of Wisdom

When post-infringement information can and cannot be used to calculate royalty damages

by Jennifer Vanderhart

One method of calculating reasonable royalty damages in patent cases, as well as in some other intellectual property matters, imagines a hypothetical negotiation between the parties. In theory, this fictional negotiation occurs just prior to the date of first infringement, and it assumes that both parties are willing negotiators and privy to all relevant information.

Although the reasonable royalty is hypothetically negotiated prior to first infringement, the courts generally have allowed information about subsequent events to be used in arriving at a reasonable royalty. However, courts also have ruled that information about subsequent events is not relevant, or not allowed, in certain circumstances. This article summarizes certain seminal, as well as more recent, decisions that address the "book of wisdom."

The term "book of wisdom" was coined in 1933 by Justice Benjamin Cardozo in Sinclair Refining Co. v. Jenkins Petroleum Process Co., 289 U.S. 689, 698 (1933), when he wrote: "[I]f years have gone by [between the issue of the patent and trial] . . . [e]xperience is then available to correct uncertain prophecy. Here is a book of wisdom that courts may not neglect. We find no rule of law that sets a clasp upon its pages, and forbids us to look within." Subsequent decisions have not always agreed that the information found within those pages should be considered. The underlying dispute as to whether information that postdates first infringement should be allowed focuses on whether damages are intended to compensate for the actual use made of the invention and its actual value as used, or the expected use and value of the invention at the time of first infringement.

There are different incentives that underlie each situation. On one side of the debate, those who do not want subsequent events to influence the hypothetical negotiation argue that doing so may overcompensate the patentee because of hold-up or lock-in costs. These are amounts based on the cost of switching from an infringing to a noninfringing technology. Hold-up costs should not be considered in a hypothetical negotiation as they are unrelated to the underlying value of the invention. However, it may be difficult to differentiate between hold-up costs and the value of the technology. Those who do not want information that becomes known after first infringement to be utilized argue that the potential licensee may be incentivized to infringe the patent, rather than to negotiate a license prior to first infringement, and then only pay based on the actual use of the patent. There would then be no risk of overpaying for the use of the patent, and perhaps no payment would be required at all. Those who want subsequent events to be considered in arriving at a reasonable royalty argue that compensation should be for the actual use made of the invention by the infringer and not the expected use predicted to be made. They argue that, depending on the accuracy of pre-infringement predictions, the patent owner may not be fairly compensated for the use made of his or her invention, or the infringer may be unfairly penalized for use not actually made.

A number of decisions, including one from earlier this year, have allowed information known subsequent to first infringement to be used in arriving at a reasonable royalty. In France Telecom, S.A. v. Marvell Semiconductor, Inc., No. 3:12-cv-04967 (N.D. Cal. Aug. 28, 2014), the court denied a motion to preclude Marvell's expert from testifying that royalties may be capped based on evidence of actual use, citing Lucent v. Gateway (discussed below). The court referenced Georgia-Pacific factor 11 ("[t]he extent to which the infringer used the invention and any evidence probative of the value of that use") in opining that "Marvell is free to argue, based on actual use of the patented method (i.e., the 'book of wisdom'), that a running royalty would not exceed a certain amount." Even more recently, in March 2017, the Court of Appeals for the Federal Circuit affirmed the district court's rulings against Sprint in Comcast IP Holdings I LLC v. Sprint Communications Co., No. 2015-1992 (Fed. Cir. Mar. 7, 2017), in which Sprint argued that prejudgment interest should have been calculated from the first infringement, not from the time of the hypothetical negotiation six years before two of the patents were even issued. Sprint contended that prejudgment interest should have been apportioned based on the royalty periods covered by the individual patents-in-suit. The court disagreed, holding that witnesses had testified that the negotiators in the hypothetical negotiation would have employed the book of wisdom, looking forward in time and accounting for all relevant information, including the later issuance of related patents.

Several earlier decisions also allow the use of information from the book of wisdom. In Fromson v. Western Litho Plate & Supply Co., 853 F.2d 1568, 1575 (Fed. Cir. 1988), the court held that the hypothetical negotiation is deemed to have occurred just prior to the date of first infringement, but allows consideration of "events and facts that occurred [after the hypothetical negotiation] that could not have been known to or predicted by the hypothesized negotiators." Citing to Fromson and Integra (discussed below), in Honeywell International, Inc. v. Hamilton Sundstrand Corp., 378 F. Supp. 2d 459, 469–70 (D. Del. 2005), the district court stated that it was "presented with two cases, both of which are binding, that dictate opposite results. . . . In this case, the court is persuaded that the result dictated by Fromson is the most sensible" because it promotes more flexibility when calculating damages, better discourages infringement by placing the risk of success on the infringer, prevents a premature valuation of the patent, and better aligns with the plain language of the patent damages statute by awarding compensation for "the use made of the invention." In Harris Corp. v. Ericsson Inc., 417 F.3d 1241, 1257 (Fed. Cir. 2005), the court allowed a royalty that was based on an initial rate and a later, and lower, renewal rate, holding that "[t]he court correctly understood [Federal Circuit precedent] as mandating consideration of a hypothetical negotiation on the date of first infringement but not automatically excluding evidence of subsequent events." In the highly publicized case of Lucent Technologies, Inc. v. Gateway, Inc., 580 F.3d 1301, 1333 (Fed. Cir. 2009), the Federal Circuit rejected Microsoft's argument that information that postdated the hypothetical negotiation was irrelevant—"neither precedent nor economic logic requires us to ignore information about how often a patented invention has been used by infringers." The court further opined that evidence of infringing use postdating the hypothetical negotiation "can, under appropriate circumstances, be helpful to the jury and the court in assessing whether a royalty is reasonable." In VirnetX, Inc. v. Cisco Systems, Inc., 767 F.3d 1308 (Fed. Cir. 2014), the court allowed the admission of licenses postdating the hypothetical negotiation to be used as comparable licenses when arriving at a reasonable royalty.

However there have been other decisions that have disallowed information learned subsequent to the date of first infringement. In Interactive Pictures Corp. v. Infinite Pictures, Inc., 274 F.3d 1371, 1385 (Fed. Cir. 2001), the Federal Circuit upheld an award that was based on pre-infringement sales projections, stating that "[t]he fact that the [accused infringer] did not subsequently meet those projections [was] irrelevant to [its] state of mind at the time of the hypothetical negotiation." In Integra Lifesciences I, Ltd. v. Merck KGaA, 331 F.3d 860 (Fed. Cir. 2003), rev'd on other grounds, 545 U.S. 193 (2005), the Federal Circuit overturned an award based on a hypothetical negotiation date in 1995. The court opined that the record was not clear as to whether the date of first infringement was 1995 or 1994, and that in 1994 there were different circumstances that would have yielded a different royalty. More recently, in Aqua Shield v. Inter Pool Cover Team, 774 F.3d 766, 770 (Fed. Cir. 2014), the court stated that "the core economic question is what the infringer, in a hypothetical pre-infringement negotiation under hypothetical conditions, would have anticipated the profit-making potential of use of the patented technology to be, compared to using noninfringing alternatives." The court also held that it is an error to cap the royalty by looking at the infringer's actual profits as "[t]his 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." Id. at 772.

Although courts often allow information that postdates first infringement to be considered when calculating a reasonable royalty, conflicting messages remain for future debate.

Keywords: litigation, commercial, business, patents, damages, book of wisdom, infringement, negotiation, royalties, intellectual property

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