October 2007

In September, the House of Representatives approved the most sweeping changes to the United States patent law in over 50 years. If ultimately passed into law, patents will be harder to obtain, and easier to challenge. Supporters claim that litigation will be curtailed by (i) limiting the jurisdiction in which lawsuits can be filed (to avoid filing in pro-plaintiff jurisdictions) and (ii) limiting damages.

The focus of this article is damages. The House (HR 1908) and Senate (S 1145) versions regarding damages are quite similar. Assuming Senate passage occurs, the changes described in this article are likely.

The existing patent damages statute is brief. Under the current law, a patentee is entitled to lost profits damages if the patentee can show that it would be able to make the defendant’s sales, but in no event can damages be less than a reasonable royalty. Case law provides specific guidance as to both damages measures.

The reasonable royalty remedy is the area of perceived abuse. The most important reasonably royalty guidance is contained in a landmark case, Georgia-Pacific Corp. v. United States Plywood Corp., 318 FSupp 1116, 6 USPQ 235 (SD NY 1970). The Georgia-Pacific case provides fifteen factors necessary to provide a sound economic evaluation. From the defense perspective, these fifteen factors are sufficiently broad to allow incorrect assessments. Consequently, the defense side of patent cases prefers more narrowly defined statutory guidance.

The changes in royalty calculations would not be profound if all reasonable royalty evaluations were prepared on a sound basis. However, proponents of the new law contend that changes are needed to reduce recent damage awards back to what has historically been allowed, and to confirm with economic reality. (For example, see Patent Damages Case Redefines a “Reasonable Royalty”.)

Procedurally, the bill specifies that:

“(1) IN GENERAL -… Based on the facts of the case, the court shall determine whether paragraph (2), (3), or (4) [specific measurement concepts listed below] will be used by the court or the jury in calculating a reasonable royalty. The court shall identify the factors that are relevant to the determination of a reasonable royalty under the applicable paragraph, and the court or jury, as the case may be, shall consider only those factors in making the determination.”

The bill then continues with the three possible royalty evaluation methods, as follows:

“(2) RELATIONSHIP OF DAMAGES TO CONTRIBUTIONS OVER PRIOR ART- Upon a showing to the satisfaction of the court that a reasonable royalty should be based on a portion of the value of the infringing product or process, the court shall conduct an analysis to ensure that a reasonable royalty under subsection (a) is applied only to that economic value properly attributable to the patent’s specific contribution over the prior art. The court shall exclude from the analysis the economic value properly attributable to the prior art, and other features or improvements, whether or not themselves patented, that contribute economic value to the infringing product or process.

(3) ENTIRE MARKET VALUE- Upon a showing to the satisfaction of the court that the patent’s specific contribution over the prior art is the predominant basis for market demand for an infringing product or process, damages may be based upon the entire market value of the products or processes involved that satisfy that demand.

(4) OTHER FACTORS- If neither paragraph (2) or (3) is appropriate for determining a reasonable royalty, the court may consider, or direct the jury to consider, the terms of any nonexclusive marketplace licensing of the invention, where appropriate, as well as any other relevant factors under applicable law.”

As with most new laws, court cases will determine what the law really means. Depending upon how one interprets the legislation, the proposed new law will have either no real change at all, or will limit plaintiffs’ allegations that are now allowable. However, most agree that the proposed law favors infringers (defendants).

Surprisingly, an established royalty rate based on past licensing is now relegated to an “Other Factor”. Such “Other Factors” are considered only if the court determines that possibilities (2) and (3) are not applicable. Currently, an established royalty is afforded the greatest weight when determining a royalty rate. However, under the legislation, the royalty is instead based on prior art (possibility #2), rather than the current perspective that focuses on the market immediately before the infringement.

This probably represents a change because some inventions are often ahead of their time, so the invention’s full economic benefit is not known until later. Although some claim the new law requires the royalty valuation to be based when the patent is issued, the legislation does not really specify this. This timing matters because, at the point when infringement begins (when damages assessments occur currently), either the inventor may have invested additional time to commercialize the patent and/or the market may have changed to make the patent more valuable. If the damages assessment must be made earlier, these economic improvements would be ignored.

The legislation may require a similar evaluation point when determining whether the entire market value rule is applicable. The entire market value rule (item #3 in the legislative quote above) allows a larger royalty base that uses the entire product being sold, and not just the piece of the product that uses the patent. However, to use the entire market value rule, the patent holder must show that the patent’s specific contribution over the prior art is the “predominant basis for market demand”. Under existing law, the entire market value rule does not reference prior art.

The electronics and software industries favor the legislation because they typically rely on multiple patents for a single product, with each patent covering incremental changes and improvements. In this situation, a challenge exists in apportioning the valued added by patent at issue, and the value added by other patents or ideas. Although such inquiries are already required under current law, the House-passed legislation makes this explicit. The electronics and software industries desire to reduce the effect of what they see as nuisance suits covering insignificant contributions

In contrast, the biotechnology and pharmaceutical industries typically have only one or two patents covering a drug. They are generally opposed to the legislation, since they see it as eroding the value of their individual key patent(s).

The legislation also requires the Under Secretary of Commerce for Intellectual Property and the Director of the United States Patent and Trademark Office to conduct a study of patent damage awards in cases where such awards were based on a reasonable royalty. The study, which is due one year from passage, will need to consider cases from 1990 to the present. The purpose of the study is to determine (i) whether reasonable royalty damages have increased, and (ii) if so, what has caused this.

Fulcrum Inquiry appraises intellectual property. We regularly prepare damages assessments, including reasonable royalty studies, for intellectual property litigation.