Federal Circuit Corrects Recurring Errors With The Entire Market Value Rule

|||Federal Circuit Corrects Recurring Errors With The Entire Market Value Rule

Federal Circuit Corrects Recurring Errors With The Entire Market Value Rule

September 2012

In LaserDynamics v. Quanta Computer, Case No. 11-1440 (Aug. 30, 2012) the U.S. Court of Appeals for the Federal Circuit overturned an $8.5 million lump sum jury award and remanded the case for a new damages trial. The Federal Circuit addressed three issues of interest to the calculation of reasonable royalties.

The Appellate Court described the technology at issue is:

“a method of optical disc discrimination that essentially enables an optical disc drive (“ODD”) to automatically identify the type of optical disc—e.g., a compact disc (“CD”) versus a digital video disc (“DVD”)—that is inserted into the ODD. … This automated process saves the user from having to manually identify the kind of disc being inserted into the ODD before the ODD can begin to read the data on the disc.”

Someone skilled in the calculation of patent infringement damages using a reasonable royalty would not expect the damages issue in this case to require (as is has here) two trials with a third trial required on remand. The expected simplicity should have occurred because the technology at issue had a significant licensing history that the Federal Circuit summarized as follows:

“LaserDynamics entered into sixteen licensing agreements from 1998 to 2001. These licenses were granted to well known electronics and ODD manufacturers such as Sony, Philips, NEC, LG, Toshiba, Hitachi, Yamaha, Sanyo, Sharp, Onkyo, and Pioneer. All of the licenses were non-exclusive licenses granted in exchange for one time lump sum payments ranging from $57,000 to $266,000. There is no evidence that these licenses recited the lump sum amounts as representing a running royalty applied over a certain period of time or being calculated as a percentage of revenues or profits. …

Several other lump sum licenses were granted by LaserDynamics between 1998 and 2003 to other ODD and electronics manufacturers via more aggressive licensing efforts involving actual or threatened litigation by LaserDynamics.

An additional two licenses were entered into in 2009 and 2010 for lump sum payments of $1 million or less. But, one last license was allowed into evidence and caused a reversal. LaserDynamics reached a settlement agreement, which the Appellate Court described as follows:

“This settlement agreement was executed into within two weeks of the anticipated trial … By the time of the settlement, BenQ [the defendant] had been repeatedly sanctioned by the district court for discovery misconduct and misrepresentation. The district court had allotted BenQ one-third less time than Mr. Kamatani for voir dire, opening statement, and closing argument, had awarded attorneys’ fees to [the Plaintiff] for bringing the sanctions motion, had stricken one of BenQ’s pleaded defenses, and had sanctioned BenQ $500,000.00 as an additional punitive and deterrent measure.”

The Appellate Court thus summarized the licensing history as follows:

“In total, twenty-nine licenses were entered into evidence in the second damages trial. With the exception of the $6 million BenQ license, all twenty-nine licenses were for lump sum amounts of $1 million or less.”

The jury found a damage award that was well outside the established royalty rate of most of the licenses, and which obviously gave weight to the BenQ license. The use of the BenQ settlement agreement pushed the limits in terms of when a settlement agreement can be used. Not that long ago, it was widely accepted that licenses involving litigation settlement were not allowed to be used in reasonable royalty calculations at all. See Federal Circuit Approves Evidence of Both Settlements and Related Negotiations in Reasonable Royalty Damages for a discussion of recent cases and background on this question.

While continuing to support the use of litigation settlements as proper evidence of a reasonable royalty, the federal Circuit overturned the trial court’s evidence ruling regarding the BenQ settlement as an abuse of discretion. The Federal Circuit explained:

“Despite the longstanding disapproval of relying on settlement agreements to establish reasonable royalty damages, we recently permitted such reliance under certain limited circumstances. See ResQNet, 594 F.3d at 870-72 (explaining that a settlement license to the patents-in-suit in a running royalty form was “the most reliable license in [the] record” when compared with other licenses that did not “even mention[] the patents-in-suit or show[] any other discernible link to the claimed technology”). We permitted consideration of the settlement license on remand, but we cautioned the district court to consider the license in its proper context within the hypothetical negotiation framework to ensure that the reasonable royalty rate reflects “the economic demand for the claimed technology.”

After repeating the facts of the BenQ settlement (reported earlier herein), the Court concluded:

“This case is therefore well outside the limited scope of circumstances under which we deemed the settlement agreement in ResQNet admissible and probative. The probative value of the BenQ settlement agreement is dubious in that it has very little relation to demonstrated economic demand for the patented technology, and its probative value is greatly outweighed by the risk of unfair prejudice, confusion of the issues, and misleading the jury. Fed. R. Evid. 403. Accordingly, we conclude that the district court abused its discretion by admitting the BenQ settlement agreement into evidence, and must exclude the agreement from the proceedings on remand.”

The most important damage calculation insight pertains to the use of the entire market rule in establishing the base that is applied to the reasonable royalty rate. The Federal Circuit explained the rule as follows:

“Where small elements of multi-component products are accused of infringement, calculating a royalty on the entire product carries a considerable risk that the patentee will be improperly compensated for non-infringing components of that product. Thus, it is generally required that royalties be based not on the entire product, but instead on the “smallest salable patent-practicing unit.”…

The entire market value rule is a narrow exception to this general rule. If it can be shown that the patented feature drives the demand for an entire multi-component product, a patentee may be awarded damages as a percentage of revenues or profits attributable to the entire product. Rite-Hite, 56 F.3d at 1549, 1551. In other words, “[t]he entire market value rule allows for the recovery of damages based on the value of an entire apparatus containing several features, when the feature patented constitutes the basis for customer demand.”

The Federal Circuit has consistently allowed the use of the rule when supported by the correct facts, but insists that the rule not be misapplied, as it found in the current case.  An earlier case involving a Federal Circuit damages ruling is discussed here. The problem in the current case involves the importance of the patented technology relative to other important features on an entire computer. The Federal Circuit explained:

“It is not enough to merely show that the disc discrimination method is viewed as valuable, important, or even essential to the use of the laptop computer. Nor is it enough to show that a laptop computer without an ODD practicing the disc discrimination method would be commercially unviable. Were this sufficient, a plethora of features of a laptop computer could be deemed to drive demand for the entire product. To name a few, a high resolution screen, responsive keyboard, fast wireless network receiver, and extended-life battery are all in a sense important or essential features to a laptop computer; take away one of these features and consumers are unlikely to select such a laptop computer in the market-place. But proof that consumers would not want a laptop computer without such features is not tantamount to proof that any one of those features alone drives the market for laptop computers. Put another way, if given a choice between two otherwise equivalent laptop computers, only one of which practices optical disc discrimination, proof that consumers would choose the laptop computer having the disc discrimination functionality says nothing as to whether the presence of that functionality is what motivates consumers to buy a laptop computer in the first place. It is this latter and higher degree of proof that must exist to support an entire market value rule theory.”

The entire market value rule is sometimes justified because it is difficult to know the component’s value to which a percentage royalty is applied. The Federal Circuit expressed little sympathy with such an explanation.

Finally, the court plainly repeated a consistent finding that the date of the hypothetical royalty negotiation is immediately before the infringement began. This has not been a source of disagreement in typical practice, but the Appellate Court needed to repeat the widely-accepted rule because an errant expert witness decided to use a different date.

Fulcrum Inquiry regularly assesses damages in  intellectual property litigation as a  damages expert witness.

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