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Methodologies For Determining Patent Damages

Title 35, Section 284 of the United States Code, often referred to as the patent statute, states that patent infringement damages should be in an amount adequate to compensate the patent holder for the defendant’s infringement of the patent-at-issue, but in no event less than a reasonable royalty for the use of the invention.

Upon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use of the invention by the infringer, together with interest and costs as fixed by the court. [Title 35, Section 284]

Courts typically award patent damages in two forms: (1) the patent holder’s actual damage, quantified as its lost profit; and (2) reasonable royalty damages calculated as the amount a willing licensee would pay for use of the invention. Established methods of calculating patent infringement damages have emerged based on Federal District Court decisions; and, since its formation, decisions by the United States Court of Appeals for the Federal Circuit (“Federal Circuit”).

Lost Profit Damages

Plaintiffs often make a determination early in the litigation whether to seek lost profit damages, or limit remedies to only a reasonable royalty. Whether or not the Plaintiff seeks lost profit damages materially influences the kinds of documents requested from the defendant in discovery.

While there is no single method for calculating lost profit damages, the most common is a four-part test first recognized 1978 in the Panduit Corporation v. Stahlin Brothers Fibre Works, Inc. case. According to the Panduit test, to obtain as damages the profit the Plaintiff would have made but for the infringement, a patent owner must prove: (1) demand for the patented product, (2) absence of acceptable non-infringing substitutes, (3) manufacturing and marketing capacity to exploit the demand, and (4) the amount of profit the patent owner would have made.

Subsequent court opinions have modified the Panduit test in various ways since 1998. The second test, absence of acceptable non-infringing substitutes has received the most attention. Among the many modifications, in the States Industries, Inc. v. Mor-Flo Industries case the Federal Circuit added a market share analysis, where, in certain instances, a patent owner confronted with non-infringing substitutes can still recover lost profit damages consistent with its historic market share.

The Federal Circuit made further refinements to the body of patent infringement damage law in its Grain Processing v. American Maize Products decision; addressing whether a design-around alternative is a true substitute if it has not been commercialized.

There are other means of proving lost profit damages in addition to the Panduit test, such as measuring increases in the cost of product inputs caused by the infringement, which are beyond the scope of this article. Generally, lost profit damages in patent cases must be proven to be reasonably probable and non-speculative.

Reasonable Royalty Damages

As with lost profit damages, there is no one single method for establishing reasonable royalty damages; however, the Federal Circuit has acknowledged two: (1) the hypothetical license negotiation approach, and (2) the analytical approach.

Hypothetical License Negotiation

The most often used approach to calculate reasonable royalty damages employs a hypothetical license negotiation by the parties to the litigation. Looking back in time, this hypothetical license negotiation occurs immediately prior to the date of first infringement. In the seminal case, Georgia-Pacific v. United States Plywood Corporation, the district court set down fifteen factors that practitioners can consider in a hypothetical license negotiation. The fifteen Georgia-Pacific factors are:

  1. Royalties received by the patent owner for the licensing of the patent in suit, proving or tending to prove an established royalty.
  2. The royalty rates paid by the licensee for the use of other patents comparable to the patent in suit.
  3. The nature and scope of the license, as exclusive or non-exclusive, or as restricted or non-restricted in terms of territory or with respect to whom the manufactured product may be sold.
  4. The licensor’s established policy and marketing program to maintain its patent monopoly by not licensing others to use the invention or by granting licenses under special conditions designed to preserve that monopoly.
  5. The commercial relationship between the licensor and the licensee, such as whether they are competitors in the same territory in the same line of business, or whether they are inventor and promoter.
  6. The effect of selling the patented specialty in promoting sales of other products of the licensee; the existing value of the invention to the licensor as a generator of sales of its non-patented items; and the extent of such derivative or convoyed sales.
  7. The duration of the patent and the term of the license.
  8. The established profitability of the product made under the patent; its commercial success; and its current popularity.
  9. The utility and advantages of the patent property over the old modes or devices, if any, that had been used for working out similar results.
  10. The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those who have used the invention.
  11. The extent to which the infringer has made use of the invention, and any evidence probative of the value of that use.
  12. The portion of the profit or of the selling price that may be customary in the particular business or in comparable businesses to allow for the use of the invention or analogous inventions.
  13. The portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.
  14. The opinion testimony of qualified experts.
  15. The amount that a licensor (the patent owner) and a licensee (the infringer) would have agreed upon (at the time the infringement began) if both had been reasonably and voluntarily trying to reach an agreement; that is, the amount that a prudent licensee – who desired, as a business proposition, to obtain a license to manufacture and sell a particular article embodying the patented invention – would have been willing to pay as a royalty and yet be able to make a reasonable profit, and which amount would have been acceptable by a prudent patent owner who was willing to grant a license.

Courts differ on what information damage experts should consider in the hypothetical license negotiations. There seems to be a movement by Federal District courts to allow subsequent events, such as the amount of profit the infringer made on infringing sales, to be considered in the hypothetical license negotiation. Practitioners sometimes refer to the inclusion of subsequent events as opening the “Book of Wisdom.”

The Federal Circuit recently reversed course with regard to a commonly used method of establishing a starting point for the hypothetical license negotiation. In the past, many practitioners have begun their hypothetical license negotiation with a base rate, or starting point, partially developed through use of a rule of thumb called the “25% Rule.” Each Georgia-Pacific factor’s influence on the starting rate is considered as either an upward, or a downward, impact. The 25% Rule emerged as a practical tool used by licensing professionals; and has been documented through empirical studies of past real-world license negotiations and the resulting royalties. In January of 2011, the Federal Circuit determined use of the 25% Rule is no longer justified.

Analytical Approach

The Federal Circuit in the TWM Manufacturing Co. v. Dura Corp. case first recognized another, less used method, called the Analytical Approach. In the TWM case, internal documents of the Defendant projected the profit margin the Defendant expected to earn on sale of the infringing product. Projected infringing profit margins were much higher than what the Defendant made on its other non-accused products, or what were normal profits to the industry. A special master compared expected profits to average profits in the industry, characterizing the difference (which became the reasonable royalty) as the amount of profit available to pay a royalty and allow the Defendant to still make normal industry profits.

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