September 2009
Many lawyers admit that they are not “a numbers person”. If you are one of these folks, you need to hire an experienced and thoughtful damages expert. Although this article discusses patent damages, the broader lesson involves the need to present a complete damages analysis at trial using an expert witness who is willing to say “no” when the client’s desired result is clearly ridiculous.
The dispute involving this case was between Lucent (which France’s Alcatel bought in 2006) and Microsoft. The Appellate Court had before it liability issues involving both patent invalidity and infringement. The Court upheld the liability findings, but vacated a $350 million award and remanded for a new damages trial because the original verdict was not supported by substantial evidence. About half of the Appellate Court’s 66-page opinion involves damages analysis. This is unusual since appellate courts have not recently addressed patent damages issues.
Patent law (35 U.S.C. § 284) requires damages of at least a reasonable royalty. The calculation involves a hindsight reconstruction of:
“the difference between [the patentee’s] pecuniary condition after the infringement, and what his condition would have been if the infringement had not occurred.” Yale Lock Mfg. Co. v. Sargent, 117 U.S. 536, 552 (1886).
This is most often done through a hypothetical negotiation which attempts to ascertain the royalty upon which the parties would have agreed had they successfully negotiated an agreement just before infringement began. Sound economic guidance regarding this determination appears in the landmark case Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. (S.D.N.Y. 1970), which lists 15 factors to be considered. In Lucent vs. Microsoft, both parties used this hypothetical negotiation approach, although their resulting conclusions were quite different.
Microsoft (MS) sold 110 million units that used the infringed software component, primarily as part of MS Outlook. Sales of the total product which included the infringed component were $8 billion. The infringement involves a user interface in which a date can be input by clicking a calendar. The non-infringing alternative is entering the same date using the keyboard. The date picker in MS Outlook’s calendar function could hardly be viewed as being critical to the total functionality of MS Outlook. MS Outlook must have a hundred user interfaces that are just as important as a calendar date picker, plus the substantial primary functionality of the entire program.
Plaintiff’s Expert Damages Witness Runs Amok
Despite the relatively unimportant functionality and available non-infringing alternative, Lucent requested $562 million in damages based on an 8% royalty rate on the full $8 billion of Microsoft’s sales. Microsoft argued that the correct licensing rate should be only $6.5 million based on a lump-sum, paid-up-front royalty. No one who thinks about this very long could fail to see the absurdity of 8% royalty on a feature that is a tiny fraction of an overall product, particularly when a non-infringing alternative is so readily available. Suppose each of MS Outlook’s numerous components are subject to a patent or otherwise deserve compensation for their use. There are only 12 ½ opportunities to pay an 8% royalty before the entire revenue value has been spent.
Most courts are happy to let juries decide whatever damages they want, and are quite reluctant to reverse the jury verdict unless there was an objected-to legal error in the lengthy jury instructions. Apparently, this was the approach taken by the trial court. At the trial court level, Lucent’s expert witness provided a bottom-line answer with little articulated support. Regardless, the trial court accepted the notion that there was evidence to support the jury’s obviously absurd conclusion.
The Appellate Court had a different standard. The Appellate Court identified numerous failings in Lucent’s damages presentation, including:
- “The license agreements for other groups of patents, invoked by Lucent, were created from events far different from a license negotiation to avoid infringement of the one patent here.”
- “Lucent identifies no documentary evidence or testimony showing the parties’ expectations as to usage of the claimed method. Lucent submitted no evidence upon which a jury could reasonably conclude that Microsoft and Lucent would have estimated, at the time of the negotiation, that the patented date-picker feature would have been so frequently used or valued as to command a lump-sum payment that amounts to approximately 8% of the sale price of Outlook.”
- “Lucent relies on eight varied license agreements which purportedly support the jury’s lump-sum damages award. … Some of the license agreements are radically different from the hypothetical agreement under consideration. … Lucent’s expert supplied no explanation to the jury about the subject matter or patents covered by those agreements.
Regarding item 3 above, the Appellate Court repeated the “scant” and “superficial” testimony on the patents, consisting of just a few questions confirming that the damages expert relied on those licenses. However, Lucent and its damages expert provided no meaningful explanation as to why these transactions would be relevant or how the transactions could be used to value the royalty at issue. The Appellate Court summarized the poor quality of expert testimony as follows:
“The testimony provides no analysis of those license agreements, other than, for example, noting the agreement was a cross-license of a large patent portfolio and the amount paid. Lucent had the burden to prove that the licenses were sufficiently comparable to support the lump-sum damages award. The law does not require an expert to convey all his knowledge to the jury about each license agreement in evidence, but a lump-sum damages award cannot stand solely on evidence which amounts to little more than a recitation of royalty numbers, one of which is arguably in the ballpark of the jury’s award, particularly when it is doubtful that the technology of those license agreements is in any way similar to the technology being litigated here.”
The Appellate Court then highlighted the key attributes of the licenses that Lucent’s expert failed to address, and the additional information not in the record that needed to be there for the jury’s result to be supported.
“Lucent’s expert never explained to the jury whether the patented technology is essential to the licensed product being sold, or whether the patented invention is only a small component or feature of the licensed product (as is the case here). …”
“As Lucent’s own expert testified, Outlook is a “personal organizer” that is “an integrated suite of abilities to do e-mail, to set up contacts, to arrange meetings, to maintain your personal calendar, et cetera.” In short, Outlook is an enormously complex software program comprising hundreds, if not thousands or even more, features. We find it inconceivable to conclude, based on the present record, that the use of one small feature, the date-picker, constitutes a substantial portion of the value of Outlook.”
“Creating a licensing agreement for patented technology is, at best, an inexact science. In actual licensing negotiations, willing parties negotiating at arms-length do not necessarily generate and analyze precise economic data concerning the perceived value of a patented invention. A complicated case this was, and the damages evidence of record was neither very powerful, nor presented very well by either party.”
Total Market Value Supported Generally, but Rejected in Lucent’s Situation
The “total market value rule” recognizes that the economic value added by a patented feature might be greater than the value of the patented feature alone. In Rite-Hite Corp. v. Kelley Co., 56 F.3d (Fed. Cir. 1995) (en banc), the Federal Circuit reviewed the background and rationale of the entire market value rule. The case also confirmed that patent infringement damages should be based on only the value of the infringing product in those instances where the patented feature is not the basis for customer demand for the entire product. When the patented device is part of a much larger product and is not the basis for the entire demand, the royalty base needs to be reduced using a process called apportionment. In the Georgia-Pacific case (described above), factor 13 directs the analyst to consider:
“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”
In addition to his numerous other mistakes, Lucent’s expert misapplied the total market rule. The Federal circuit explains:
“Our law on the entire market value rule is quite clear. For the entire market value rule to apply, the patentee must prove that “the patent-related feature is the ‘basis for customer demand.’” Rite-Hite, 56 F.3d at 1549 … [Yet], the only reasonable conclusion supported by the evidence is that the infringing use of the date-picker tool in Outlook is but a very small component of a much larger software program. The vast majority of the features, when used, do not infringe. The date-picker tool’s minor role in the overall program is further confirmed when one considers the relative importance of certain other features, e.g., e-mail. Consistent with this description of Outlook, Lucent did not carry its evidentiary burden of proving that anyone purchased Outlook because of the patented method. Indeed, Lucent’s damages expert conceded that there was no “evidence that anybody anywhere at any time ever bought Outlook, be it an equipment manufacturer or an individual consumer … because it had a date picker.”
… What Lucent’s licensing expert proposed here does not comport with the purpose of damages law or the entire market value rule. Lucent’s expert tried to reach the damages number he would have obtained had he used the price of the entire computer as a royalty base. Being precluded from using the computer as the royalty base, he used the price of the software, but inflated the royalty rate accordingly. This cannot be an acceptable way to conduct an analysis of what the parties would have agreed to in the hypothetical licensing context.”
The total market value has been the source of criticism regarding some of the large patent verdicts. However, the Federal Circuit specifically supported the use of the rule generally, as follows:
“Some commentators suggest that the entire market value rule should have little role in reasonable royalty law. …But such general propositions ignore the realities of patent licensing and the flexibility needed in transferring intellectual property rights. The evidence of record in the present dispute illustrates the importance the entire market value may have in reasonable royalty cases. The license agreements admitted into evidence (without objection from Microsoft, we note) highlight how sophisticated parties routinely enter into license agreements that base the value of the patented inventions as a percentage of the commercial products’ sales price. There is nothing inherently wrong with using the market value of the entire product, especially when there is no established market value for the infringing component or feature, so long as the multiplier accounts for the proportion of the base represented by the infringing component or feature.”
In the last few years, Congress considered numerous proposals for patent reforms. Patent damage reform is not necessary since the existing laws (if properly considered) are already sufficient to arrive at economically-based just results. The current Lucent vs. Microsoft case is noteworthy because the Federal Circuit took the unusual step of becoming actively involved in damages determination, rather than simply letting the jury result stand. If more appellate rulings did this, there would be much less need for any patent reform.
Fulcrum Inquiry regularly assesses damages in intellectual property litigation as a damages expert witness.