June 2012

Patent law (35 U.S.C. § 284) allows for lost profits in patent infringement cases, but requires damages of at least a reasonable royalty even if lost profits cannot be substantiated. The determination of a reasonable royalty 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. vs. U.S. Plywood Corp., 318 F. Supp. (S.D.N.Y. 1970), which lists 15 factors to be considered.

Over two years ago, in connection with a review of ResQNet.com, Inc. v. Lansa, Inc., Nos. 08-1365, -1366, 09-1030 (Fed. Cir. Feb. 5, 2010), we noted that it is generally accepted that licenses arising in settlement of litigation are not appropriate comparables for use in a reasonable royalty analysis. However, in reviewing a particularly poor reasonable royalty analysis, the Federal Circuit noted that litigation-related licenses would have generated a better answer than the incomplete analysis that the trial court accepted. The Federal Circuit commented:

“This court observes as well that the most reliable license in this record arose out of litigation. On other occasions, this court has acknowledged that the hypothetical reasonable royalty calculation occurs before litigation and that litigation itself can skew the results of the hypothetical negotiation. See Hanson v. Alpine Valley Ski Area, Inc., 718 F.2d 1075, 1078-79 (Fed. Cir. 1983) (“

[S]ince the offers were made after the infringement had begun and litigation was threatened or probable, their terms should not be considered evidence of an ‘established royalty,’ since license fees negotiated in the face of a threat of high litigation costs may be strongly influenced by a desire to avoid full litigation.”)

Nevertheless, based on the first sentence in the above quote, multiple district courts have accepted litigation-oriented licenses as useful and appropriate evidence. For example, in a recent district Court case in the district where Fulcrum resides, the district court observed in re: Raymond Caluori v. One World Technologies, Inc., No. CV 07-2035-CAS (VBKx) (C.D. Cal. Feb. 27, 2012:

“In opposition, plaintiff argues that it was not improper for [plaintiff’s damages expert] to rely on the [settlement] Agreement in determining the reasonable royalty rate for a hypothetical negotiation between plaintiff and [defendant]. In support of this argument, plaintiff cites ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860, 872 (Fed. Cir. 2010), in which the Federal Circuit “observ[ed] as well that the most reliable license in this record arose out of litigation.”
“Plaintiff argues that if it were unclear whether a settlement agreement could be used to establish a royalty rate before ResQNet, numerous district court holdings demonstrate that the issue is now resolved.”

This district court’s observation now has additional support. In re MSTG, Inc., No. 11-M996 (Fed. Cir. Apr. 9, 2012), the Federal Circuit ruled in connection with a discovery ruling that, in addition to settlement agreements, documents associated with the negotiation of the settlement are also discoverable. Obviously, if the underlying settlement agreements were not admissible, then there would be no need to even consider the issue that the Federal Circuit just decided. The Federal Circuit described the situation faced by the district court as follows:

“Although the expert had “reviewed the six [settlement] agreements and taken them into consideration in [his] reasonable royalty analysis,” he did not find the royalty rates in those agreements to “be comparable to the hypothetical negotiation between MSTG and AT&T.” This was so because most of the royalty agreements were “litigation related compromises,”, and because they covered additional patents beyond the patents-in-suit. There was no showing that the expert had access to the negotiation documents, though he relied on deposition testimony of an MSTG executive that the agreements reflected litigation-related compromises. …

The expert concluded that the rates in the settlement agreements were “discounted by at least 75%” because they were entered before any substantive litigation rulings such as claim construction or summary judgment. On this issue, the agreements themselves did not support the opinion.”

In ruling that the additional settlement negotiation documents are admissible, the district court concluded that:

“…[d]ocuments related to negotiations could shed light on why the parties reached their royalty agreements and could provide guidance on whether some or all of the licenses could be considered a basis for calculating a reasonable royalty.”

The Federal Circuit concluded that the settlement negotiations were discoverable for the following six reasons:

  1. “There is no state consensus as to a settlement negotiation privilege. Although all states have apparently enacted a statutory mediation privilege, …We are not aware of any state that recognizes a settlement privilege outside the context of mediation.”

  2. “In adopting Rule 408 of the Federal Rules of Evidence, Congress directly addressed the admissibility of settlements and settlement negotiations but in doing so did not adopt a settlement privilege.”

  3. “In determining whether new privileges should be recognized, the Supreme Court has been influenced by the list of evidentiary privileges recommended by the Advisory Committee of the Judicial Conference in its proposed Federal Rules of Evidence.”

  4. “While there is clearly an important public interest in favoring the compromise and settlement of disputes, disputes are routinely settled without the benefit of a settlement privilege. It is thus clear that an across-the-board recognition of a broad settlement negotiation privilege is not necessary to achieve settlement.”

  5. “Rule 408 itself contemplates a host of scenarios under which documents related to settlement negotiations would be admissible for purposes other than “prov[ing] or disprov[ing] the validity or amount of a disputed claim or impeach[ing] by a prior inconsistent statement or a contradiction.” For example, settlement negotiation evidence would be admissible where the settlement itself or its interpretation is at issue or where evidence of the ingredients of the settlement might be relevant to an issue of double recovery.”

  6. “To the extent we need to protect the sanctity of settlement discussions and promote the compromise and settlement of dispute, there are other effective methods to limit the scope of discovery to achieve those ends—primarily Rule 26 of the Federal Rules of Civil Procedure.”

In other rulings, the Federal Circuit has limited evidence and methodologies that are suitable for determining a reasonable royalty. The use of settlement evidence partially makes up for these other limitations.

Fulcrum Inquiry performs  valuations of intellectual property, including for  damage analysis in patent infringement litigation.