Can Reasonable Royalties Ever Exceed Lost Profits?

Powell v. The Home Depot U.S.A., Inc., 2011 U.S. App. LEXIS 22838 (Nov. 14, 2011)

 Ten years ago Home Depot noticed employers were getting injured operating their in-store radial saws. The company began testing a prototype developed by Michael Powell, who’d long provided installation and repair services for the in-store radial saws.  The tested units proved effective, and he applied for a patent.

In the meantime, however, Home Depot invited another, larger, company (Industriaplex) to build a design that was cheaper than what it had paid for the prototype ($2,000). By 2006, Powell had his patent, but Home Depot had already ordered nearly 2,000 saw guards from Industriaplex and Powell sued for patent infringement. Ultimately, a jury awarded $15 million in damages, or approximately $7,736 per infringing unit. After the court added $3 million for enhanced damages plus another $2.8 million in attorneys’ fees, Home Depot appealed to the U.S. Court of Appeals for the Federal Circuit.

Damages measured at the time of infringement. After confirming the findings of willful infringement and related liability issues, the Federal Circuit turned to the damages award. First, Home Depot argued that a reasonable royalty could never exceed the plaintiff’s lost profits. “While either the infringer’s or the patentee’s profit expectation may be considered in the overall reasonable royalty analysis,” the court began, citing Georgia-Pacific factors, “it is settled law that an infringer’s net profit margin is not the ceiling by which a reasonable royalty is capped” (court’s emphasis). The rule applies equally to the situation here, in which the infringer argues that the patentee’s projected profits should cap the calculations:

Indeed, damages to the patent holder cannot simply be calculated in all cases by determining the difference between his pecuniary condition after the infringement and what his condition would have been if the infringement had not occurred.

Moreover, had the plaintiff successfully negotiated a deal with Home Depot after his creation of the prototype in 2004, a “conservative” estimate of his expected profits would have been $2,180 per unit at the time. However, a reasonable royalty must be calculated at the time infringement began, the court held, in this case, when the plaintiff received his patent in 2006. By this time, “Home Depot had the luxury of nearly two additional years . . . to observe the effectiveness of the saw guard solution created by [the infringing design],” the court said. As a result, an expected profit of $2,180 per unit in 2004 was not a “reliable approximation of the upper limit that the parties would have reached during a hypothetical negotiation in 2006.”

As a second matter, Home Depot argued that damages should have been limited by what it paid for the Industriaplex design, or $1,295 per unit, which was equivalent to a 3% to 5% royalty on infringing sales. “Even at a grossly high royalty rate of 50%,” Home Depot argued, the plaintiff could not have received more than $1.3 million in damages.

Injury rate fell to zero. In contrast, at trial the plaintiff’s expert presented a range of damages, bounded on one end by the $2,180 per-unit price during the 2004 negotiations and on the other by the roughly $8,500 per unit that Home Depot spent to replace the radial saws with the infringing design in 2005. Further, the expert testified why the parties would have negotiated a lump-sum, reasonable royalty over the life of the patent that was higher than the plaintiff’s expected lost profits, based on consideration of the Georgia-Pacific factors.

For instance, he noted that after the CEO mandated the installation of saw guards, the injury rate among Home Depot employees dropped to zero, saving the company over $1 million in annual costs. In addition, while its major competitor (Lowe’s) chose to remove radial saws from their stores, Home Depot was able to continue to provide custom-cut lumber, protecting these profits as well as those from related sales of hinges, nails, etc.  He also presented the amount that Home Depot spent on replacing any saw guards that were incompatible with the infringing design.

“Reliance upon estimated cost savings from use of the infringing product is a well-settled method of determining a reasonable royalty,” the Federal Circuit pointed out. Likewise, a jury may consider not only the patentee’s benefit in licensing the technology, but also its value to the infringer, including in this case, Home Depot maintaining its competitive advantage. By comparison, Home Depot’s damages theory focused on the incorrect time (two years prior to infringement) and the incorrect amounts (what it paid to Industriaplex rather than what it would have paid to the plaintiff).

At base, the “paucity” of evidence presented by Home Depot represented “nothing more than what it might have preferred to pay, which is not the test for damages,” the court held, in affirming that the jury’s $15 million compensatory award was based on sufficient if not “extensive” evidence. Based on evidence of willfulness and litigation misconduct, the court also confirmed the award of enhanced damages and attorneys’ fees.

By Sherrye Henry, Esq., Legal Editor, Business Valuation Update