Royalties in a cash bag

Damages for reasonable royalties, in comparison to damages for lost profits, generally correspond to an assumption based upon what the parties would have agreed upon if they had negotiated a royalty amount prior to an infringement. This concept is referred to generally as ‘hypothetical negotiation.’ There are several techniques, both using the hypothetical negotiation approach, as well as other more analytical based approaches, that have been used in prior cases for the calculation of reasonable royalty damages in patent infringement matters, including the 25 percent rule of thumb, Georgia-Pacific factors, and the Nash Bargaining Solution. In recent years, however, the techniques employed by experts in the calculation of royalty damages in patent infringement disputes, have been subject to heightened judicial scrutiny.

While the 25-percent rule was found to be “fundamentally flawed,” and therefore essentially eliminated, based upon the 2011 decision in Uniloc, U.S.A. v. Microsoft Corp., this ruling did not categorically preclude use of the rule, if and only if, it is used in accordance with Daubert standards. In Uniloc, the expert used the 25 percent rule to determining a baseline royalty rate in a hypothetical negotiation, and then used the Georgia-Pacific factors to determine if there should be an increase or decrease in damage amount. The court found that Uniloc’s expert, in using a calculation approach, which began with the 25-percent rule, was inappropriate under Daubert standards. Therefore, while no direct reference to the 25 percent rule of thumb should be employed by any wise practitioner in the vast majority of disputes, for the limited disputes the rule may be appropriately used, its application, as asserted in Uniloc, must “carefully tie proof of damages to the claimed invention’s footprint in the market place.”

As used in conjunction with the 25-percent rule in Uniloc, the Georgia-Pacific factors is another calculation method used to assess royalty damages. Although there has been no definitive rejection of this method, as there was with the 25 percent rule, this method, too, has been heavily scrutinized in a variety of recent decisions. The Georgia-Pacific factors extends from the ruling in Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970), mod. and aff’d, 446 F.2d 295 (2d Cir. 1971), cert. denied, 404 U.S. 870 (1971), and includes 15 specific factors. Keeping in mind that not all 15 factors will apply in a given case, the Georgia-Pacific factors are as follows:

1. The royalties received by the patentee for the licensing of the patent in suit, proving or tending to prove an established royalty.
2. The 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 his 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 licensee, such as, whether they are competitors in the same territory in the same line of business; or whether they are inventor and promotor.
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 his 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 (such as the patentee) and a licensee (such as 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 which 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 patentee who was willing to grant a license.

A more recent emergence is the use of another method of calculation, the Nash Bargaining Solution, named after John Nash, the Nobel-Prize winning mathematician. This method was created as an attempt to resolve issues between varying calculation techniques, by providing a set of conditions that could reasonably apply to any bargaining situation. Just like other methods of calculation, this too, has been both accepted by some courts and rejected by others. Opponents to this method have argued that it bears too similar of a methodology to the 25- percent rule, and therefore would result in unreasonably high damage award. In Oracle v. Google 798 F. Supp 2d 1111 (N.D. Cal. 2011), the court, while citing to the decision in Uniloc, addressed the Nash Bargaining Solution, and in rejecting it stated that “[t]he Nash bargaining solution would invite a miscarriage of justice by clothing a fifty-percent assumption in an impenetrable facade of mathematics.” However, other courts have accepted the use of the Nash-Bargaining solution when used a reasonableness check against an accepted method, such as the Georgia-Pacific factors, as was the ruling in Mformation Techs v. Research in Motion Ltd. 2012 U.S. Dist. LEXIS 56784 (N.D. Cal. March 29, 2012).

Additional calculation techniques have also been recognized, such as the analytical approach, used in  TWM Manufacturing Co. v Dura Corp., 789 F. 2d 895 (Fed. Cir. 1986), cert. denied, 479 U.S. 852 (1986). In contrast to the hypothetical negotiation approach, this method evaluates the projected profits of the infringer, which is then used to determine a damage amount based the portion of projected profit that should be attributed to the patent holder. In rejecting the defendants’ challenge to the use of this approach based upon the plaintiffs’ failure to use the Georgia-Pacific factors, the court stated “Dura has cited nothing which would limit the district court’s discretion in choosing the analytical approach to determine a reasonable royalty. Section 284 does not mandate how the district court must compute that figure, only that the figure compensate for the infringement.”

Because litigation expenses associated with the use of an expert in calculating royalty damages can be quite costly, both for a claimant’s support of a purported amount, and a defendant’s challenge of amount, rate, or calculation method, the litigators to such disputes may find themselves holding a superior position over their opponent by fully understanding not only the various methods, but also the manner in which court have scrutinized them. The most important consideration is that calculation techniques be assessed on a case by case basis. In addition, when using one technique as a reasonableness check for another, practitioners must keep in mind that when a baseline technique is flawed, rejected, or otherwise inadmissible, that the technique used as a check for reasonableness will likely be rejected as well. Accordingly, while understanding the varying calculation methods is a good starting point, understanding their application to a particular case at hand is, by far, the more crucial consideration.

By: Alicia McKnight, J.D.