Federal Circuit ramps up the apportionment calculus for damages calculations

In yet another sign that the Federal Circuit is tightening the evidentiary standards for proving damages in patent utility cases—especially for those concerning “small elements of multi-component products”—the court has just held, in a new case, that any royalties resulting from infringement must be based “on the smallest saleable patent-practicing unit.”

The “entire market value rule” (EMVR) is the only—and ever-narrowing—exception to this standard, the court added. Only when the patented feature “drives the consumer demand” for the product can the product’s entire revenues provide a baseline royalty. It is not enough to show that the patented feature was “valuable, important, or even essential” to the product—in this latest case, a laptop computer that contained the patented optical disc drive (ODD) technology. “Nor is it enough to show that a laptop computer without an ODD … would be commercially unviable,” the Federal Circuit held. Instead, the patentee must meet the “higher degree of proof” that the presence of the patented functionality “is what motivates consumers to buy a laptop computer in the first place.”

The court also affirmed well-established precedent (from an 1884 Supreme Court case) that a patentee “must in every case give evidence tending to separate or apportion” the defendant’s profits from a product between its patented and unpatented features, a calculus that has become an “exceedingly difficult and error-prone task”—particularly for today’s more sophisticated electronic devices that include dozens of distinct and separately patented components.

Applying this higher standard in the case, the Federal Circuit made several important rulings regarding the plaintiff’s expert evidence presented in two prior trials before the federal district court (E.D. Tex.). Among them, it found that the expert had improperly applied the EMVR, used the wrong valuation date and pricing structure, and relied on a litigation-spawned license that was “far from reliable.” Read the complete digest of LaserDynamics v. Quanta Computer, Inc., 2012 U.S. App. LEXIS 18441 (Fed. Cir., Aug. 30, 2012) in the November Business Valuation Update; the Federal Circuit’s opinion will soon be posted at BVLaw.

Have the courts gone too far with the ‘entire market’ rule’ in calculating damages?

In a cogent essay in Patently-O, Dennis Crouch takes on current judicial applications of the “entire market rule” in damages calculations, arguing that forbidding use of an “entire-product royalty base” removes an excellent starting point for calculating the incremental benefit of the patent infringed.

In fact, since apportionment is a product of multiplication, damages calculated as a royalty against the offending component should equal damages calculated as a royalty against the entire market because the royalty rate is much smaller for the latter. “In the multi-component situation, what’s wrong with allowing the defendant to make the (seemingly easy and intuitive) showing that the accused product is based on thousands of innovations and equally important underlying patents that each deserve (and have received) their share of royalties and that the stacking problem means that royalties for the particular invention in question certainly could not be above say 0.002%?”

Crouch acknowledges a cognitive bias may well exist, that a royalty rate of a microfraction of a percent (of the total market) may be difficult for a juror to comprehend, but concludes that is just a lawyering problem. “To avoid the small number bias problem, defendants can rescale their calculation to be something like $5 per thousand products sold.”

PwC study of 2011 patent litigation finds ‘reasonable royalty’ the leading method for calculating damages

Though it is no surprise to hear, the number of patent infringement actions filed in 2011 hit an all-time record high (4,015), according to a recently released report from PwC. Chris Berry, partner in forensic services at PwC,pointed out the importance of trends in damage awards to valuation analysts: “With the courts paying more attention to damages methodologies and calculations, patent litigation counsel and damages experts should monitor ongoing rulings that could affect damages opinions.”

The report points out that of the three kinds of damages—lost profits, price erosion, and reasonable royalty—reasonable royalty is far and away the most common award. PwC offers an explanation for this:

1. Nonpracticing entities (NPEs) are generally not eligible for lost profits (removing NPEs from the equation still leaves reasonable royalty as the most favored method to calculate damages);
2. “The complexity and costs of the analysis for determining lost profits is usually greater than it is for reasonable royalties.” (Analysts reviewing the lost profits option should refer to the expert commentary in Nancy Fannon’s Calculating Lost Profits in IP and Patent Infringement Cases.); and
3. Lost profits may be more difficult to establish than a reasonable royalty. The greater the number of competitors in a market, the more alternatives to substitute products, the more difficult it is to prove the effect of infringement on sales and profits.

Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 1978, established four questions that need to be answered for a patent holder to receive damages in the form of lost profits. These questions are commonly referred to as the Panduit factors:

i. Is there a demand for the patented products?
ii. Are there substitute products available?
iii. Did the patent holder have the wherewithal to exploit the demand?
iv. Despite the answers to i, ii, and iii, can lost profits be quantified?

First benchmark guide for remaining useful lives of intangibles identified in business combinations

• Private equity groups, financial analysts, investors, operating management, and CFOs have been on their own in estimating remaining useful lives of intangible assets without significant benchmarks since the Financial Accounting Standards Board (FASB) created the uniform procedure. Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations is an easy-to-navigate study that delivers a compilation of reported data, particularly on useful lives of intangible assets, reflected in 360-plus purchase price allocations (PPAs).

Analysts can utilize this data to benchmark what intangibles are being discovered, categorized, and valued in industries and the ratios of individual intangible asset categories to total assets. The inclusion of key statistical data means this study can be used to benchmark noncompete agreements, support statistical claims of the dominance of intangible assets, and assist in identifying amortization tendencies.