In ResQNet.com, Inc. v. Lansa, Inc., Nos. 08-1365, -1366, 09-1030 (Fed. Cir. Feb. 5, 2010), the United States Court of Appeals for the Federal Circuit (CAFC) provides useful instruction regarding common (but poor) practices that are seen in reasonable royalty damages analyses in patent infringement cases.
The CAFC referenced its recent decision in Lucent Technologies, Inc. v. Gateway, 580 F.3d 1301 (Fed. Cir. 2009), which we summarize in a related reasonable royalty damages article. Like the Lucent case, the plaintiff in the Lansa matter sought and obtained reasonable royalty damages at the trial court level. In both cases, the CAFC found severe shortcomings in the plaintiff’s expert witness analysis, leading the case to be remanded back to the trial court to determine damages.
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.
The first Georgia Pacific factor involves analyzing the patentee’s comparable licenses that could indicate a royalty for the patent in suit. In calculating a 12.5% royalty rate, the CAFC opinion indicated that ResQNet’s expert meaningfully used only this first factor. No doubt, a more comprehensive Georgia Pacific analysis would have identified the failures in the limited work and improper application pertaining to this first factor. From the CAFC Opinion:
“He considered a few of the other Georgia-Pacific factors, but dismissed them because for the most part, the other factors have no real impact here.’ … The inescapable conclusion is that [the expert] used unrelated licenses on marketing and other services—licenses that had a rate nearly eight times greater than the straight license on the claimed technology in some cases—to push the royalty up into double figures.”
In applying this first factor, ResQNet’s expert used (i) five licenses that included non-patented services such as training, maintenance, marketing, and upgrades, and (ii) two licenses which occurred in settlement of litigation. The first five licenses did not specifically mention the patents in suit and did not show any other link to the claimed technology. In the quote above, the CAFC described these five patents as “unrelated licenses on marketing and other services“. The CAFC’s further description follows:
“Yet the expert used licenses with no relationship to the claimed invention to drive the royalty rate up to unjustified double-digit levels. The expert based his damages on seven ResQNet licenses, five of which had no relation to the claimed invention. These five re-branding or re-bundling licenses (hereinafter, the “re-bundling licenses”) furnished finished software products and source code, as well as services such as training, maintenance, marketing, and upgrades, to other software companies in exchange for ongoing revenue-based royalties. These companies obtained the right to re-brand ResQNet’s products before resale or bundle these products into broader software suites. While the specific numbers involved in these licenses are under a protective order, this court observes that two of them mentioned a top rate of 25%, two more a top rate of 30%, and still another a top rate of 40%. Notably, none of these licenses even mentioned the patents in suit or showed any other discernible link to the claimed technology.
The CAFC was also concerned about the two licenses arising from litigation. The CAFC described these two licenses as follows:
“Those two “straight” licenses arose out of litigation over the patents in suit. One of them was a lump-sum payment of stock which the expert was unable to analogize to a running royalty rate. The other was an ongoing rate averaging substantially less than 12.5% of revenues.”
It is generally accepted that licenses arising in settlement of litigation are not appropriate comparables for use in a reasonable royalty analysis. Nevertheless, wayward experts occasionally use litigation-related licenses in a Georgia-Pacific analysis. The CAFC noted that, because the rest of the expert’s analysis was so incomplete, that litigation-related licenses would have generated a better answer than what the trial court accepted. Nevertheless, litigation-related licenses should not be used. From the CAFC Opinion:
“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) (“Since 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.”)
Practical Damages Applications from this Case
This Opinion has the following practical impacts on reasonable royalty calculations:
- A proper reasonable royalty analysis should consider all of the Georgia Pacific factors. Certain of these factors call for accounting and economic analyses that are widely applicable. It is difficult to justify (as ResQNet’s expert attempted) that these economic factors have limited or no applicability.
- The twelfth Georgia Pacific factor is, “The portion of the profit or of the selling price that may be customary in the particular business or in comparable businesses to allow for the use of the invention or analogous inventions”. This factor is often addressed by a review of other licenses in the same industry. As with any valuation, judgment is needed in evaluating whether these other licenses (which are not for the patent in suit) are suitable for appraisal purposes. In practice, this type of comparison is sometime performed by “industry experts”, who generally do not perform research or apply a rigorous economic analysis. Instead, such industry experts rely on their experience to state what they believe this particular industry would pay for the technology at issue. As currently used, industry experts who rely solely on experience (vs. economic analysis) face an unacceptable risk that their conclusions will not be upheld. The use of industry experts to comment on so-called comparable technology is insufficient unless supported by the rest of the Georgia Pacific factors.
- Since licenses using the same technology are needed in this first factor, the temptation to use licenses that were obtained in settlement of litigation will be that much greater. Nevertheless, such licenses do not provide a suitable starting point for a reasonable royalty analysis.
- The 25% rule (See Steps in Valuing Intellectual Property for background on this rule) is often used in reasonable royalty analyses. This rule of thumb has been widely discredited, but still shows up in “expert” analyses because it is easy and inexpensive to apply. Nevertheless, the 25% rule does not meet the requirements of the Lansa case for consideration of the specific technology at issue.
- At the trial court level, the defendant did not put on any expert testimony. The CAFC commented that they thought the trial court was unduly influenced by the lack of expert rebuttal testimony. The CAFC properly observed that the plaintiff has the burden of proof, and the plaintiff had not met this burden with their expert testimony. Nevertheless, everyone can probably quickly agree that having to win a reversal at the CAFC was more risky and expensive than obtaining qualified expert testimony at the trial court level.
In both ResQNet vs. Lansa, and Lucent vs. Gateway, the CAFC threw out the plaintiff’s poorly-conceived reasonable royalty analysis. In both cases, the royalty rates found at the trial court level lacked any sense of marketplace reality. These two plaintiffs should have presented a more complete analysis that stood a chance of being upheld. Both defendants should have employed a capable damages expert witness at trial to identify the problems that caused the trip to the CAFC.