The Economics of Patent Damages Presented by Ryan Ford University of Nevada October 8, 2013
- Offices in Emeryville, CA and Pasadena, CA. - Economic consulting services: Antitrust/Competition t/c titi Business Valuation Commercial Transactions Intellectual Property Litigation
Ryan Ford Consultant -BA/MA in Economics from San Jose State University ( 06/ 07) -Worked at ERS Group/Competition Economics ( 07-present) -Economics Instructor at SMC/PCC ( 07-present) -Worked on 22 patent cases, 5 commercial damages & trade secret cases, 5 anti-trust assignments. Cases dealing with: -Plasma televisions -Software encryption -Cell phone camera features -Oilfield services technology -Barcode scanning equipment -Electronic detonators -Fashion design -Television internet connectivity -Margarine formulations -Mobile aerial camera systems -Airline mergers -Groundwater contamination
The views expressed in this presentation are those of the author and do not necessarily reflect the views of Competition Economics or others.
Unique Properties of Patents A property p right created purely to facilitate a public policy goal Intangible until put into practice Rely on claim construction to define meaning Presumption of validity, but can be invalidated
Unique Properties of Patent Damages Patent infringement is civil and not criminal Infringement is presumed non-willful Damages are to compensate, not provide automatic injunctive relief Patent damages impact the value of patents which in turn ties to the public policy goal of the patent system
Balancing Act of Patent Damages Law Promoting innovation by offering protection for a specific invention for a limited period of time in return for public disclosure of that invention.
Balancing Act of Patent Damages Law This also creates: Restraint of competition, resulting in higher prices for consumers, and potential anti-commons issues. We want to encourage innovation but doing so is We want to encourage innovation, but doing so is costly. How much innovation do we want?
Patent Damages Damage awards associated with patent infringement are required to be adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer. (35 U.S.C. 284) Lost Profits Reasonable Royalties
Lost Profits Lost Profits claims can include: Incremental profit of lost sales by the patentee Price erosion The Panduit factors require: -evidence of demand for the patented product -evidence concerning the presence acceptable non-infringing substitutes -evidence concerning manufacturing and marketing capacity to exploit the demand for its spae patented edinvention -calculation of the amount of profit that the patentee would have earned in the absence of the alleged infringement (Panduit Corp. v. Stahlin Bros. FibreWorks, Inc., 575 F.2d 1152 (W.D. Mich. 1975), 197 USPQ 726 (6th Cir. 1978))
Evidence of demand for the patented product Proving Panduit Characteristics of the infringer s product may be different than the patentee s product. If I couldn t buy the infringer s product, is there enough evidence to support that I would have bought the patentee s product instead? Evidence concerning the presence acceptable non-infringing substitutes The infringer, or other competitors, may be able to provide a non-infringing substitutes. If a noninfringing product exists, is there enough evidence to support that I would have bought the patentee s product instead? Evidence concerning manufacturing and marketing capacity to exploit the demand for its patented invention Lost profits sales are typically additive to the patentee s current sales. Is there evidence that the patentee t could have actually fulfilled the market demand d for all of its own sales as well as the infringing i i sales which it is claiming lost profits for? Calculation of the amount of profit that the patentee would have earned in the absence of the alleged infringement Does the evidence exist which allows me to calculate the lost profits? (Tends to be a greater issues in price erosion claims)
Can t ProvePanduit? Panduit? When Panduit factors can t be proven or established, one of fthree scenarios exists: The patentee is a NPE (non-practicing entity) The patentee has not yet commercialized their product The patentee is a direct competitor that fails to satisfy the 4 Panduit factors The bargaining position of the patentee in each of these scenarios is appreciably different.
Reasonable Royalties A reasonable royalty is generally determined by evaluating the economic conditions and other factors that t would have been considered d by the parties if they had negotiated a license agreement. - Create a hypothetical agreement that would have taken place at the time of first infringement - Both parties are aware that the patent(s)-in-suit are valid and infringed - Use knowledge available at the time of first of infringement, as well as future knowledge - Weigh facts to determine the royalty rate range and bargaining power of the parties
Common Reasonable Royalty Framework To Determine the Royalty Considering the 15 Georgia-Pacific Factors 1. Royalties patent holder has received for licensing patent 2. Royalties paid by accused infringer to license comparable technology 3. Scope of license that would have been negotiated 4. Patent holder's policy of licensing patents 5. Commercial relationship between patent holder and accused infringer 6. Accused infringer s ability to make other convoyed sales 7. Remaining life of patent 8. Profitability of accused products 9. Advantages of invention over alternatives 10. Benefits of invention 11. Extent t accused infringer i uses invention 12. Portion of profits paid for comparable technology/industry royalty rates 13. Portion of profits that should be credited to invention 14. Opinions of experts 15. Amount a willing licensor/willing licensee would agree on
Grouping of Factors for Analysis Licensing/Royalty Rates Factors 1, 2, 4, 12 & 13
Reasonable Royalty: The Hypothetical ti Negotiation Product sales Continued growth of product sales Product design Production decisions Product released Notice of infringement First Infringement: Date of Hypothetical Negotiation The hypothetical negotiation occurs after product design and production decisions have already been made and costs have already been sunk. This has an impact on the cost for an infringer to switch to a non- infringing alternative at the time of the hypothetical negotiation.
Reasonable Royalty: The Hypothetical ti Negotiation Product sales Continued growth of product sales Product design Production decisions Product released Notice of infringement First Infringement: Date of Hypothetical Negotiation Start of Damages Patentees have an incentive to delay notice to wait until the revenue (and cost of design around has grown). The common law doctrine of laches can be used, also patent damages law tries to account for this with by setting notice of infringement as the start of damages. However you can seek damages as far back as 6 years prior to the filing of the complaint.
Reasonable Royalty: What Information Can One Use? Using knowledge not available at the hypothetical negotiation ( Book of Wisdom ) Without the use of actual knowledge about future sales, the hypothetical negotiation would introduce unnecessary speculation. Expert 1 product expected to be an immense success Used to support high royalty Expert 2 great uncertainty t surrounding product success Used to support low royalty Should the Book of Wisdom be used? How does it impact damages? Actual results tend to be greater than pessimistic uncertainty and less than best case sales projections. Therefore incorporating actual knowledge tempers analysis, Therefore incorporating actual knowledge tempers analysis, ties it to reality and avoids reliance on speculation in expert testimony.
Applied Reasonable Royalty Concepts Direct competitors may not be able to prove Panduit factors and thus may not have access to lost profits. This introduces an issue Can a willing license between direct competitors always be constructed? When the two parties are direct competitors and the patentee wishes to maintain their patent monopoly, the construct of a willing hypothetical negotiation between two parties breaks down. Georgia-Pacific Factor 5: Commercial relationship between patent holder and accused infringer GP 5 necessarily introduces potential lost profit elements into the reasonable royalty analysis when the parties are competitors.
Anti-Commons Issues & Incentives Anti-commons issues create unique incentives: Firms will create e patent arsenals as Firms will enter into standards groups (often with with RAND terms) RAND (Reasonable-and-non-discriminatory) terms in agreements sound logical, but then often will result in subsequent litigation. What is a reasonable rate? How can this be predetermined? Additionally, there is a positive relationship between the number of firms entering into standards organizations and the value of hold up. Therefore, successful standards groups can result in firms selling patents to NPEs to avoid RAND commitments, which reintroduces anti-commons issues.
Legal Hierarchy of Patent Law The Supreme Court (USSC) United States Court of Appeals for the Federal Circuit (CAFC) U.S. District Courts
Grain Processing Corp. v. American Maize-Products Co (CAFC, 1999) Grain Processing allowed an infringer to claim that it would have offered a noninfringing product that, although not actually sold in the marketplace, was technically feasible at the time of first infringement and could have been made commercially available relatively quickly. This makes it easier to argue for design around possibilities, and thus lowers damages for patentees. As a result, this decreases the value of patents and reduces the incentive to invent. Was Grain Processing the right call? With over 150,000 U.S. patents published each year, firms can have difficulty knowing if their product design and feature choices will infringe a patent (this is one of the reasons why there is a presumption of non-willfulness). Without Grain Processing what alternatives would be available to me once I am found to infringe? Would I be locked into early stage design decisions? Grain Processing allows for a more proper valuation of patents by considering possible non-infringing alternatives.
Does Grain Processing encourage infringement? Post-Grain Processing one may now face a unique incentive to willfully infringe instead of design around. This is because if caught infringing, one will simply argue that they could have used the hypothetical non-infringing g method. Thus reducing their damages ages to the cost one would have incurred in the first place to design around the patentee s invention. If legal and product redesign costs are low, a rational economic actor will therefore almost always choose to infringe as the probability of successful litigation is less than 100%, giving g the prospective infringer a free option to infringe. Incorrect as: Switching costs typically increase at latter stages of production. Willful infringement allows for damages to be increased by up to a factor of 3. Note interesting side effect of willful infringement penalties: This statutory penalty is designed to discourage wonton infringement, however it also incentivizes firms not to do patent searches when designing products.
ebay Inc. v. MercExchange (USSC, 2006) Eliminated automatic injunction rule, especially in instances where parties are not direct competitors. ebay stated that to grant a permanent injunction, a patentee must satisfy a four-factor test: (1) That it has suffered an irreparable injury. (2) That remedies available at law, such as monetary damages, are inadequate to compensate for that injury. (3) That, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted. (4) That the public interest would not be disserved by a permanent injunction.
ebay Inc. v. MercExchange (USSC, 2006) Eliminated automatic injunction rule, especially in instances where parties are not direct competitors. Injunctions can allow for higher post trial royalties than reasonable royalties available for past damages. This is because the opportunity cost for switching may be quite different post-trial than at the hypothetical negotiation. Non Practicing Entities (NPEs) or Patent Assertion Entities (PAEs) present unique anti- commons issues, because their royalty requests are not tempered by fear of reciprocal litigation. Thus limiting injunctive relief to NPEs helps to reduce anti-commons issues, however it also reduce patent infringement remedies and thus reduces the value of patents. In effect it creates different value for different patent holder types, practicing entities vs. non-practicing entities. NPEs can still attempt to attain injunction through the ITC (International Trade NPEs can still attempt to attain injunction through the ITC (International Trade Commission). The ITC does not offer monetary damages, with injunctions as their only available remedy for infringement.
Lucent v. Gateway (CAFC, 2009) Acknowledged that in some instances settlements provide the most comparative license to the hypothetical. Settlement agreements are not arms length patent license agreements and are inherently biased to the facts and circumstances underlying the settlement between the two parties. Where you are in negotiations and when you settle (based on certain information, e.g. bad claims construction) can impact outcomes. Thus settlement agreements should generally be excluded from consideration. However all patent license agreements are under the threat of litigation and most patent license agreements take place with uncertainty. Thus in many respects, all patent licenses are settlement agreements. What do you do if the only available licenses are settlements? You must try to take into account unique factors of settlements. However incorporating settlement agreements introduces new issues. If a patentee sues multiple parties, then early settlements can be strategically constructed.
Uniloc v. Microsoft (CAFC, 2011) Uniloc prevented experts for using the 25 percent rule or any rule of thumb to arrive at a reasonable royalty. The 25 percent rule originated from general, cross-industry observations about the portion of profits retained by a patentee in a patent license (typically not 50% as patentee incurs less risk). The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say any-thing about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party. Uniloc v. Microsoft CAFC Slip Opinion, p. 45 (1/4/2011). Suppose a patent relates a feature in Windows 7. Expert may conclude that 25% of Microsoft s incremental profit for Windows 7 is a reasonable royalty. Uniloc was a reaction to poor analysis in the valuations of patents which resulted in wide use by experts of a 25% royalty rate on profits.
Uniloc v. Microsoft (CAFC, 2011) If you can isolate the portion of the infringer s profits that are clearly enabled by the patent, t there still needs to be a division i i of those profits between the patentee and the infringer. Suppose you can isolate a portion of the sales prices which relates a feature in Windows 7. Without a rule of thumb by what standard do you divide the incremental value between the patentee and the infringer? This has resulted in the use of an increasing use of the economic Edgeworth box approach, therefore the 25 percent rule has now been supplanted by the 50 percent rule. Th i Ed th b i i it i l id The economic Edgeworth box is no more precise, it simply provides a different starting point with different underlying assumptions.
Selected FTC Recommendations In assessing how the market would have rewarded the invention absent infringement, courts should allow a patentee flexibility in creating the but for world to address different losses and avoid under-compensation. Patentees should not be denied an opportunity to establish lost profits through application of rigid rules that do not reflect sound economic principles or imposition of evidentiary requirements beyond what is required for the court to make a reasonable approximation of the patentee s loss. To prevent damage awards based on switching costs, courts should set the hypothetical negotiation at an early stage of product development, when the infringer is making design decisions and before it has sunk costs into using the patented technology. Courts should recognize that when it can be determined, the incremental value of the patented invention over the next-best alternative establishes the maximum amount that a willing licensee would pay in a hypothetical negotiation. Courts should not award reasonable royalty damages higher than this amount. What are the impacts of these recommendations? Who would be helped or hurt by their statutory enactment?
Economic Consulting Firms NERA Economic Consulting CRA International FTI Consulting Berkeley Research Group (BRG) (formerly LECG) Navigant Consulting Huron Consulting The Brattle Group