Disgorgement in Intellectual Property Litigation

The Romag Decision

In a recent decision, the U.S. Supreme Court once again addressed the award of infringer profits, or disgorgement, in IP matters. In Romag Fasteners, Inc. v. Fossil Group, Inc., 140 S. Ct. 1492 (2020), the Court held that willfulness was not a requirement for an award of disgorgement in a trademark infringement matter. In 2016, the Supreme Court addressed disgorgement as it relates to design patent infringement, opining that “total profits” to be disgorged could mean total profits after an allocation of profits to the infringing feature. (Samsung Elecs. Co. Ltd. et al. v. Apple, Inc., 137 S. Ct. 429, 436 (2016)). These two decisions generally appear to bring the remedies available under different IP regimes more in line with one another, although it remains to be seen if there are any practical differences that emerge.

From an economic standpoint, the Romag decision is reasonable because once profits are allocated, an award of disgorgement is a payment to the plaintiff for the value of its IP in the infringing product. There is no need for a distinction, then, for awarding disgorgement only in the case of willful infringement if the purpose is to award the plaintiff the value contributed by its intellectual property. As discussed below, disgorgement of a defendant’s profits, once allocated, would theoretically equate to the hypothetically negotiated reasonable royalty if the defendant had no bargaining power and the cost of the next best non-infringing alternative was too high. It is understood that because the defendant’s profit might exceed the lost profits that can be estimated for the plaintiff, an award of lost profits may not provide the necessary incentive to deter infringement. Indeed, even if the defendant knew that it was infringing, it may determine that it is better off by doing so if the probability of detection is uncertain or if the defendant believes it will earn greater profits than the plaintiff would have earned.

Analysis of Disgorgement and Important Considerations

Under a disgorgement claim, in all instances except for design patents, the burden is on the plaintiff to show revenue associated with the accused products. Once the plaintiff makes that showing, the burden shifts to the defendant to prove offsetting costs and allocation. For design patents, on the other hand, it is the defendant’s burden to show that the appropriate article of manufacture is something less than the entire product because the defendant is better equipped with the information necessary to prove costs and has the best knowledge of other factors contributing to the profits of the accused products. While there is typically some dispute over which costs are appropriate, the larger debate is often over the allocation of profits. A defendant will want to show the benefit conferred, and therefore the profit attributable, to elements other than the IP at issue. This would include not only other features of an accused product but also its brand, distribution network, established customer base, and other factors. Ideally, this process results in identifying the specific value contributed by the IP at issue apart from other factors that also contribute to profit.

The economic incentives created for a potential infringer insofar as the exercise of due care or the avoidance of willful infringement will be, in part, controlled by the damages that will be paid if found liable for any such infringement. The greatest incentive will typically be if all profits of the item with the infringing feature must be disgorged. Generally, this is found for design patents only when the article of manufacture can be shown to be the entire product or, in certain instances, when the defendant is unable to allocate effectively. When the infringer’s profits can be allocated to just the infringing feature, the strong incentives of total disgorgement are weakened and the remedy defaults, in theory, to a reasonable royalty in which the defendant has no bargaining power. From an economic standpoint, this would be an equitable remedy in the sense that it would be the maximum that the defendant would have been willing to pay for the IP.

In certain instances, disgorgement is used as a proxy for the lost profits of the plaintiff, and it may be considered when estimating lost profits for the infringement of a utility patent. But, as a disgorgement calculation, there may be no relationship between the two remedies.

Given the factors that are required to prove lost profits, a plaintiff often has to resort to a reasonable royalty, typically an amount lower than lost profits and considered a floor for damages. Reasonable royalty damages are often for situations in which a plaintiff is a non-practicing entity or when its but-for profits cannot be reliably estimated. In theory, a reasonable royalty is what would have been agreed to if the parties had negotiated prior to the infringement. If the hypothetical negotiation works as theoretically postulated, then the infringer is no better off waiting and negotiating after being caught than it would be if it had negotiated prior to infringing. While seen more often in patent and trademark cases, damages based on a reasonable royalty have been upheld for all of the above-mentioned areas of IP.

The plaintiff’s lost profits will often be the second largest damages calculation, and to the extent that the loss of sales can be shown to have been caused by the infringement, the entirety of a plaintiff’s lost profits is damages. This puts the plaintiff back in the position it would have been in but for the infringement. Depending on the relative market positions of the parties, this amount may leave the defendant profiting from its infringement to a certain extent, whereas the plaintiff is no worse off having been awarded the profits it would have earned.

One economic argument against a remedy of disgorgement is that it may over-deter the socially optimal level of innovation. However, when a defendant’s profits are not fully disgorged and are, instead, first subject to allocation, the possibility of overdeterrence is reduced, if not eliminated. In theory, there could be no difference between an allocation of an infringer’s profit to the value contributed by the infringing feature and the calculation of a royalty designed to capture the value of the infringing feature.

In practice, of course, there are reasons these calculations will not be the same. For instance, under the scenario of a hypothetical negotiation, the negotiating power of each side is taken into consideration. In addition, prior licenses may be taken into account, which may not reflect the value of the IP to the defendant. Also, if the IP is a utility patent, there may be a viable and cost-effective non-infringing alternative. Moreover, in a reasonable royalty calculation, the plaintiff is required to do any necessary allocation. Allocation can be a challenging exercise, and if the plaintiff is not able to find a reasonable basis for allocation, its entire damages case could be in jeopardy. When apportioning an infringer’s profits, however, it is the defendant’s burden to allocate, and in that case the penalty for not being able to do so also effectively lies with the defendant. Indeed, it may be the case that the entirety of its profits on the item that includes the infringing element may be damages. This asymmetry between damages in utility patent infringement and other areas of IP creates a disincentive for patent owners to litigate as compared with owners of other forms of IP.

In a one-shot game, any of these results may be seen as being Pareto-optimal in that both the parties are at least as well off as they would be in the but-for world without infringement, not taking into account the costs of the litigation. And while a plaintiff and defendant may only find themselves opposite one another on a single occasion, their litigation is just one match in a much broader repeated game. In an acknowledgement that economic damages do not fully compensate an injured party because of transaction costs, other amounts—such as attorney fees—can sometimes be recovered. However, the availability of such damages is far from certain.

After accounting for allocation, allowing for the disgorgement of the defendant’s profit in IP matters provides another tool for the calculation of damages specifically associated with the IP at issue. The last two Supreme Court rulings addressing disgorgement have resulted in conclusions that support an expanded availability of damages calculations based on disgorgement analyses.

Jennifer Vanderhart is a PhD economist with Analytics Research Group, LLC.

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