November 2011

Lost profits are typically understood to yield higher damages than reasonably royalties, but this is not always the case. Higher reasonable royalty damages most frequently occurs when the patent holder (inventor) is not in a position to exploit the invention by manufacturing the product himself. In such event, (i) the inventor cannot make profits from the self-manufacture, (ii) the royalty rate reasonably becomes lower because of the inventor’s weaker negotiating position, and (iii) the royalty is determined using the Georgia Pacific factors that are typical in a reasonable royalty calculation. In Powell vs. The Home Depot USA, Inc., Case No. 07-CV-80435 (S.D. Florida), the Federal Circuit Court went far beyond these normal parameters.

The Federal Circuit summarized the underlying facts as follows:

“For many years, Mr. Powell had a business relationship with Home Depot as its point-of-contact for the installation and repair of radial arm saws. Home Depot uses radial arm saws in its stores to cut the raw lumber it sells down to a smaller size, based on a customer’s preference.

In 2002 and 2003, Home Depot took note of an alarming trend. Its employees were suffering injuries including lacerations and finger amputations caused while operating in-store radial arm saws to cut lumber for customers. Top corporate officers, including the CEO, learned of the employee injuries and directed Home Depot’s safety personnel to either fix the radial saws to prevent injuries or remove them from all stores. … Mr. Powell—recognizing that removal of radial arm saws in Home Depot stores would hurt his business—set out to develop a solution to employee injuries. In July 2004, he presented a saw guard prototype to Home Depot, which then ordered eight production units for use and testing in stores. By August 2004, those production saw guard units were installed in Home Depot stores …

Unbeknownst to Mr. Powell at the time he installed his invention for in-store testing, Home Depot contacted another company, Industriaplex, to build and install saw guards for its radial arm saws. Home Depot invited Industriaplex to view Mr. Powell’s invention and asked it to build nearly identical copies at a price less than the $2,000 per saw guard it paid Mr. Powell for the in-store testing units. Industriaplex agreed. Home Depot eventually ordered nearly 2,000 saw guards built by Industriaplex for approximately $1,295 per unit….

The jury awarded $15 million, or approximately $7,736 per unit, in damages as a reasonable royalty that Mr. Powell would have received from Home Depot.” The jury awarded royalties as a damage measure. The standard for a reasonable royalty is what a reasonable licensee and reasonable licensor would have agreed upon. Although the Federal Circuit Court mentions the Georgia Pacific factors, the Court never directly addresses the plaintiff’s willingness to provide the fully-implemented invention for around $2,000. Since this $2,000 price included the full manufacture and installation costs, the plaintiff’s profits from this arrangement would be less than the approximate $2,000 selling price.

Economically, one cannot claim that it would be reasonable for the plaintiff to want more than 100% of the plaintiff’s full selling price as a royalty. With such a royalty, the patent holder makes more than it ever could have made itself, yet someone else performs all of the work to implement the invention. Nevertheless, that is exactly what the jury concluded, and what the Federal Circuit Court upheld.

In justifying the damage award, the Federal Circuit Court noted the economic factors Home Depot considered in deciding that the saw guard should be used in its stores, as follows:

“Home Depot employees had suffered numerous injuries before the saw guards were installed with injury claims costing Home Depot upwards of $1,000,000 per year. The jury heard that Home Depot CEO, Mr. Robert Nardelli, informed his staff that employee accidents were not acceptable and the radial arm saws must be fixed or removed. Rather than follow the lead of a close competitor—Lowe’s—and remove radial saws from their stores, Home Depot chose to pursue a solution to employee injuries and maintain a competitive advantage in its ability to provide customers with custom-cut lumber. By installing saw guards, the jury learned that not only would Home Depot maintain this competitive advantage in the market for cut lumber, it could also protect its profits from follow-on purchases of nails, hinges, and other goods that are often purchased simultaneously with cut lumber. Finally, the jury learned of the success that Industriaplex saw guards had achieved in preventing employee injuries by December, 2005. Through internal Industriaplex e-mails, the jury discovered that not a single injury had been suffered from the use of radial arm saws in Home Depot stores where the saw guards were installed. In stores where the saw guards were not installed, employees continued to be injured when using the radial arm saws.”

There is no question that, as the Federal Circuit and other precedent court rulings have held, sound economics allows:

“Reliance upon estimated cost savings from use of the infringing product is a well settled method of determining a reasonable royalty.”

By focusing on the defendant’s cost savings, the Federal Circuit Court upheld the jury’s royalty of more than $7,700, as described earlier. However, cost savings should not be the end of the analysis, with all other economic considerations ignored. The plaintiff was willing to sell the complete device that used the patent for around $2,000, so how could a royalty for just the patent reasonably exceed $7,700?

The Federal Circuit Court arrived at a somewhat similar damages decision in 2007 using the same defendant’s cost savings rationale. Like here, the Federal Circuit in the prior matter concluded that a royalty exceeding the readily-available gross sales price for the patented product by several times was reasonable.

Fulcrum Inquiry frequently addresses intellectual property damages issues as an expert witness.