United States: Early Assessment Of IP Damages Can Prove Beneficial

Last Updated: January 11 2008
Article by Charles F. Kuyk and Glenn W. Perdue

"As originally published in Expert Perspective, a Crowe Chizek and Company LLC publication, Summer 2006. All rights reserved."

In litigation associated with intellectual property (IP) — patents, trademarks, copyrights, and trade secrets — management's and counsel's attention may be directed more to the liability dimension of a case than to the issue of damages. Authors Charlie Kuyk and Glenn Perdue, however, advise the careful and early assessment of potential damages to better inform case strategy and decisions.

One of the fundamental purposes of intellectual property law is to provide economic protection to a company's or an inventor's intellectual property rights. While the ultimate resolution of a case may occur through an injunction or an economic award, it is important for counsel and management to consider the subject of damages in the early stages.

With this in mind, a basic understanding of the primary measures of recovery for infringement within each category of intellectual property is important. Familiarity with the nature and proof of damages in each category can be beneficial in several ways.

First, it will help management and counsel make an informed judgment concerning the size of the ultimate award that may result from an infringement action. This, in turn, will influence the type and magnitude of resources that are devoted to the case. Second, an understanding of the approach to determining damages will influence the type and number of witnesses, both fact and expert, who will be required to prosecute or defend the case.

In addition, knowing the measure of damages for a particular infringement action will influence the scope and focus of discovery. For example, knowing in advance that disgorgement of the defendant's profits is a possible remedy in a trademark infringement case, plaintiff's counsel will seek discovery of the defendant's sales, costs, and operating expenses — information that would be unnecessary under a lost profits approach.

Economic remedies for the different types of IP infringement have some measures of recovery in common, but they also have distinctive elements that must be considered. The chart shown below illustrates these similarities and differences.

Intellectual Property Damages Matrix

 

Patent

Trademark

Copyright

Trade Secrets

Reasonable Royalty

YES
Explicit Floor Value

   

Future Use Provision in Uniform Trade Secrets Act

Plaintiff's Lost Profits

YES

YES

YES

YES

Defendant's Gained Profits

 

YES

YES

YES

Statutory Damages

 

YES
Generally $500-$100,000 per ... special section for domain names

YES
Generally $250-$50,000 per ... can be trebled

 

Other

 

Corrective Advertising
Goodwill Injury

 

Head Start

Patent Infringement Damages


The starting point for measuring damages in a patent infringement case is Section 284 (the Patent Statute) of Title 35 of the U. S. Code (U.S.C.). This section states that:

Upon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement but in no event less than a reasonable royalty for the use made of the invention by the infringer.

The measure of damages in a patent infringement case generally is:

  1. An amount derived from the difference between the claimant's profits after the infringement and the profits the claimant would have made absent the infringement (e.g., lost profits);
  2. A reasonable royalty; or
  3. A combination of lost profits and a reasonable royalty.1

In a typical lost profits scenario, the claimant/patentee asserts it has the capacity to exploit the patented invention and can demonstrate that it would have gained additional incremental profits absent the infringement.

In other cases where the claimant lacks this capacity — such as with an inventor who lacks the manufacturing, distribution, or marketing capabilities needed to exploit his or her invention — the measure of damages is based on a reasonable royalty. In most cases, when a claimant has the capacity to profitably manufacture, distribute, and market an invention rather than simply license it, damages measured by lost profits will lead to a larger damage amount than a royalty-based damage conclusion.

Lost Profits

Gaining an award of lost profits requires the patent owner to offer proof that it could have made sales that the infringer made had the infringement not occurred. The standards for this proof have evolved during many years through a series of cases emanating (in recent times) from the landmark case Panduit Corp. v. Stahlin Brothers Fibre Works, Inc.2

To recover damages for patent infringement based on a lost profits methodology, the patent owner must show that it would have received the additional profits "but for" the infringement. The patent owner bears the burden of presenting evidence to demonstrate a reasonable probability that it would have made the asserted profits without the infringement.3

To recover damages based on profits from sales the claimant would have made without the infringement, specifically the sales made by the infringer, the so-called Panduit test required the patent owner to prove:

  • A demand for the patented product;
  • An absence of acceptable noninfringing substitutes;
  • The manufacturing and marketing capability to exploit the demand; and
  • The amount of the profit the claimant would have made.

Since the Panduit court's opinion in 1978, federal circuit case law concerning patent infringement damages has advanced significantly, particularly with respect to the second Panduit factor. Today, a more expansive view of acceptable noninfringing alternatives exists that may require reconstructing the market in which the patented technology would have been available in order to assess lost sales. A complete discussion of this evolution, however, is beyond the scope of this article.4

Once the amount of lost sales from the infringement has been determined, the damage expert will deduct the incremental costs associated with those sales to arrive at incremental lost profits. This can sometimes be a challenge because of the difficulties inherent in estimating incremental costs. These costs can bear different relationships to changes in sales. For example, some costs vary directly with changes in sales whereas others are relatively fixed. Various accounting and econometric techniques can be used to facilitate this analytic process.

Price erosion — the reduction in the price of a product caused by the marketplace impact of the infringing products — is another aspect of lost profits that may also be considered. In this case, the sensitivity of demand for a product resulting from changes in price, or "price elasticity," is an important consideration. Price elasticity is a measure of how much consumers modify their buying decisions based on changes in price. The existence of substitute products, of course, influences the consumers' buying decisions.

Reasonable Royalties

The Patent Statute, 35 U.S.C. Section 284, provides that the court shall award not "less than a reasonable royalty." A reasonable royalty represents a "floor" for the measure of damages in a patent infringement case. In determining a reasonable royalty, the economics of the patented technology, the accused product(s), and relevant markets are all considered.

To establish a reasonable royalty amount, the damages expert generally will consider 15 factors set forth in Georgia-Pacific Corporation v. U.S. Plywood-Champion Papers Inc. in forming his or her opinion.5

Depending on the particular facts of a case, reasonable royalties, such as royalty provisions in actual license agreements, may be structured in many ways including:

  • A lump-sum royalty (paid in a single installment or in stages);
  • A fixed recurring royalty (for example, monthly or annual fees paid regardless of use);
  • A per-unit royalty (continuous royalty based on the licensee's use of the technology calculated on a per-unit rate times the number of units); or
  • A percent royalty (continuous royalty based on a percentage of revenue realized or costs saved through the use of the subject technology).

Reasonable royalties provide an alternative measure of damages for any portion of the infringing sales for which the plaintiff could not justify a claim for lost profits. Reasonable royalties are based on the proposition of a hypothetical negotiation between the patent owner (plaintiff/licensor) and infringer (defendant/licensee) on the eve of the alleged infringement.

In this hypothetical scenario, the plaintiff and defendant willingly agree to a royalty value in a hypothetical license agreement, the intent being to simulate what would have happened if the parties had negotiated a deal on their own prior to the infringement.

Trademark Infringement Damages


Trademarks are protected from infringement under common law as well as statute through the Lanham Act.6 This act permits registration of four types of marks: trademarks, service marks, certification marks, and collective marks.7 Infringement of a trademark is essentially the unauthorized use of the mark in the same market in which the owner of the trademark operates.

A fundamental issue addressed in trademark infringement cases is whether the use of the infringing mark resulted in confusion in the minds of consumers located in the relevant marketplace. Once the infringement of a trademark has been established, injunctive relief to prevent further infringement is a crucial remedy.

When it can be established that the infringement contributed to actual confusion in the market or was willful, a plaintiff may be entitled to monetary recovery based on:

  • Actual damages suffered by the plaintiff and measured by lost profits, price erosion, and reputational damage (compensation for reputational damage may include the expense of corrective advertising to remediate the harm);
  • The defendant/infringer's ill-gotten gains (for example, profits);
  • The costs of the action;8
  • A reasonable royalty;9 and
  • Statutory damages of $500 to $100,000 per counterfeit trademark (up to $1 million per mark for willful violations) and $1,000 to $100,000 per unlawful domain name.10

Calculating lost profits and reasonable royalty damages in trademark cases is consistent in approach with the methods described for patent infringement cases. With trademark infringement, however, more forms of damage recovery are available since the plaintiff may also pursue the defendant's profits and statutory damages.

With statutory damages (amounts that are pre-established by law because of the difficulty in determining actual damages), a plaintiff may seek recovery for each infringement (as in copyright cases) or for each counterfeit mark per type of good or service sold (as in trademark counterfeit cases).11

In contrast to the relatively straightforward approach to calculate statutory damages, determining damages based on the defendant's illegally obtained profits may prove more challenging. In part, this is due to the relative paucity of court decisions on this topic compared to the more abundant guidance on the calculation of a plaintiff's lost profits and the determination of a reasonable royalty.

The accounting for a defendant's ill-gotten gains starts with the determination of the defendant's infringing revenue, responsibility for which falls to the plaintiff through discovery of the defendant's financial records. The burden for completing the accounting for profits then shifts to the defendant who first must apportion revenue between infringing and non-infringing sales, and then apply deductions to recognize incremental costs associated with the infringing sales.

Consistent with the calculus of measuring lost profits, only those sales made through the use of the infringing mark should be included along with deductions for incremental costs associated with these revenues. Apportionment and incremental cost information may, in some cases, be difficult to isolate with precision.

The apportionment process seeks to quantify the contribution of the protected rights to the products or services of the defendant infringer who improperly exploited those rights.12 Consequently, courts may grant some latitude in evaluating these factors compared to assessing lost profits under the "incremental profits" standard for determining a plaintiff's lost profits.

Finally, courts may increase an award by up to three times the actual damages under circumstances of willfulness or trademark dilution if the increase represents compensation rather than a penalty.13

Copyright Infringement Damages


Calculating damages in copyright infringement matters is similar to that of trademark infringement and includes the following types of potential recovery methods by the plaintiff:

  1. Actual damages of the plaintiff;
  2. The defendant/infringer's illicitly gained profits; and
  3. Statutory damages.

Statutory damages of between $200 and $150,000 for any single infringed work may be awarded by the court in copyright infringement matters. Additionally, back license fees from the prior infringing use of copyrighted materials may be doubled in certain circumstances.14

Theft Of Trade Secrets


The recovery of damages from the infringement of patents, trademarks, and copyrights is governed by federal law. Both federal and state laws govern domestic trade secret protection and damages.15 State-level trade secret laws have been substantially harmonized by virtue of the Uniform Trade Secrets Act, model legislation that has been adopted by 45 states to date.

The means of damage recovery in trade secret cases are comparable to those available in trademark cases. Specifically, damages may be recovered based on the plaintiff's lost profits or the defendant's gained profits. A reasonable royalty may provide an acceptable alternative measure of damages. Unlike trademark infringement, there is no provision for statutory damages in trade secret cases.

One nuance presented in trade secret matters is the notion of a "head start" period that represents the time it would have taken the defendant to develop the trade secrets legally. The head start period may be a consideration in determining the appropriate damage period and amount.

Intellectual Property Infringement


Damages based on the plaintiff's lost profits are the only damage remedy common to all forms of intellectual property infringement. Reasonable royalty damages, while playing a prominent role in patent infringement damage awards as an explicit "floor value," provide an alternate measure of damages for other forms of infringement.

The defendant's illegally gained profits serve as a measure of damages only in nonpatent cases. Finally, statutory damage provisions only exist for trademark and copyright cases.

Attorneys and company management involved in IP litigation may benefit from considering economic damage issues early in their case for several reasons. Different claims for infringement will have unusual implications for damages because of the varying methods of recovery.

Similarly, different claims for infringement will have an impact on tactical plans for discovery and witness selection. Finally, gaining a good understanding of the potential financial exposure early in a case will be of value in settlement negotiations and discussions with insurers.

Footnotes

1. For an example of a case involving recovery of both lost profits and reasonable royalties, albeit on different product parts, patented and non-patented, see King Instruments, Inc. v. Perego, 65 F. 3d 941 (Fed. Cir. 1995).

2. Panduit Corp. v. Stahlin Brothers Fibre Works, Inc., 575 F.2d 1152 (6th Cir. 1978).

3. See, for example, Del Mar Avionics, Inc. v. Quinton Instr. Co., 836 F.2d 1320, 1326, 5 USPQ2d 1255, 1260 (Fed.Cir.1987)

4. Among the more prominent cases shaping the evolution of the market reconstruction theory for proving lost profits in patent infringement cases are the following: State Industries, Inc. v. Mor-Flo Industries, Inc. 883 F.2d 1573 (Fed. Cir. 1989), BIC Leisure Products, Inc. v. Windsurfing Int'l, Inc., 1 F.3d. 1214 (Fed. Cir. 1993), and Grain Processing Corp. v. American Maize-Products Co., 185 F.3d 1341 (Fed. Cir. 1999)

5. Georgia-Pacific Corporation v. U.S. Plywood-Champion Papers Inc , 318 F. Supp. 1116 (S.D.N.Y. 1970).

6. Title 15 of the U.S. Code

7. 15 U.S.C. § 45.

8. 15 U.S.C. § 35 addresses recovery for violation of rights and states: "the plaintiff shall be entitled . . . to recover (1) defendant's profits, (2) any damages sustained by the plaintiff, and (3) the costs of the action. The court shall assess such profits and damages or cause the same to be assessed under its direction. In assessing profits the plaintiff shall be required to prove defendant's sales only; defendant must prove all elements of cost or deduction claimed."

9. Unlike the preceding forms of recovery for trademark infringement, this form arises from case law, not statute. See, for instance, Sands, Taylor & Wood v. Quaker Oats Co., 34 F.3d 1340 (7th Cir. 1994). In Sands, the court noted that the royalty provided a "form of restitution designed to prevent unjust enrichment." In general, a royalty-based approach can be considered when calculating the plaintiff's lost profits is not feasible.

10. 15 USC § 1117, see sections (c) and (d)

11. Ibid.

12. It should be noted that apportionment can also be a factor in determining reasonable royalties for infringement actions. Factor 13 of the Georgia-Pacific case indicates consideration of: "The portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer." And, the House Bill H.R. 2795, regarding the Patent Act of 2005, contains a proposed amendment to Section 284 with the following: `In determining a reasonable royalty in the case of a combination, the court shall consider, if relevant and among other factors, the portion of the realizable profit that should be credited to the inventive contribution as distinguished from other features of the combination, the manufacturing process, business risks, or significant features or improvements added by the infringer."

13. 15 U.S.C. § 35: "In assessing damages the court may enter judgment, according to the circumstances of the case, for any sum above the amount found as actual damages, not exceeding three times such amount. If the court shall find that the amount of the recovery based on profits is either inadequate or excessive the court may in its discretion enter judgment for such sum as the court shall find to be just, according to the circumstances of the case. Such sum in either of the above circumstances shall constitute compensation and not a penalty. The court in exceptional cases may award reasonable attorney fees to the prevailing party."

14. USC 17 § 504 / Release date: 2005-08-01 (http://www4.law.cornell.edu/uscode/html/uscode17/usc_sec_17_00000504----000-.html).

15. If foreign parties are involved in trade secret misappropriation, the Economic Espionage Act of 1996 may govern remedies, including damages.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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