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:

  1. “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.”
  2. “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.”
  3. “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