United States: Sales of Non-Infringing Products Relevant to Reasonable Royalty

The U.S. Court of Appeals for the Federal Circuit has affirmed a trial court’s admission into evidence of expert testimony regarding sales of non-infringing products that were promoted by making the infringing product available free of charge as relevant to a reasonable royalty determination. Micro Chemical, Inc. v. Lextron, Inc. Case No. 02-1155 (Jan. 24, 2003).

Micro Chemical and Lextron supply "animal health products," including drugs and equipment used to treat illnesses afflicting cattle. In an effort to promote sales of their animal health products, Micro Chemical and Lextron provide their feedlot customers with computerized medical records systems for tracking health histories and medical treatments of livestock. Micro Chemical’s medical records system is the commercial embodiment of the invention described and claimed in U.S. Patent No. 5,315,505 (the `505 patent).

Turnkey Computer Systems, Inc. supplies accounting system software to feedlots, including an animal records module that tracks health and treatment histories of livestock. Turnkey allegedly underpriced its animal records module in order to support sales of its accounting system.

Micro Chemical sued Lextron and Turnkey alleging infringement of the `505 patent. The defendants stipulated that their original systems infringed the `505 patent, but claimed that they had modified their systems to remove the allegedly infringing feature. Micro Chemical later amended its complaint to limit its infringement allegations to the defendants’ unmodified systems and trial was set to determine the amount of damages from the date the patent issued to the dates when the defendants modified their systems.

Prior to the trial, the defendants unsuccessfully moved to preclude expert testimony to the effect that the modified systems, which were not in existence during the period of infringement, could not be considered non-infringing alternatives for purposes of determining the amount of damages. The defendants also unsuccessfully sought to exclude testimony that a reasonable royalty for Lextron’s infringing computer systems should be based on revenues from sales of its animal health products. The district court ruled that while Micro Chemical could not recover a royalty on the animal health products themselves, it could present testimony that sales of animal health products were relevant to a reasonable royalty determination based on Micro Chemical’s allegation that the defendants used their infringing systems as loss leaders to promote animal health product sales.

The Federal Circuit rejected the defendants’ argument that the trial court failed to exercise its gatekeeping function: "When, as here, the parties’ experts rely on conflicting sets of facts, it is not the role of the trial court to evaluate the correctness of facts underlying one expert’s testimony." The Court noted that Rule 702 does not "authorize a trial court to exclude an expert’s testimony on the ground that the court believes one version of the facts and not the other." Where a party has ample opportunity to rebut an expert’s damages theory during cross-examination and has presented its own competing theory through the testimony of their own expert witness, the district court does not abuse its discretion in allowing an expert to testify based on a disputed version of the facts.

The Federal Circuit also found that the testimony regarding sales of feed products was relevant to "[t]he effect of selling the patented specialty in promoting sales of other products of the [infringer]," a factor set forth in Georgia-Pacific. The Court found that whether placing the infringing systems in feedlots actually promoted derivative sales of the defendants’ other products is a question of fact for the jury.

Finally, the Federal Circuit agreed that the trial court’s admission of expert testimony to the effect that the defendants’ modification of their systems in 1997 would not have reduced the royalty rate that would have been agreed upon in a hypothetical negotiation in 1994, was not legally erroneous and the testimony "…was merely based on Micro Chemical’s version of the disputed facts."

Practice Note: In another case between the same litigants decided by the Federal Circuit five days later, the Court reversed a summary judgment ruling that Micro Chemical was not entitled to an award of lost profits. Micro Chemical sued Lextron for infringement of its patent directed to a machine that dispenses feed additives to livestock and poultry feed by weight. The district court held that Micro Chemical could not recover lost profits because it could not demonstrate demand for the patented product and absence of available, non-infringing substitutes. The Federal Circuit reversed, holding that the non-infringing substitute, which was developed in 1997, was not available during the infringement period and, therefore, Micro Chemical was entitled to an opportunity to prove lost profits. The Court also found that because it was reasonably foreseeable that Micro Chemical would have made profits from microingredient sales earned by virtue of placing its patented weigh machines on feedlots, a damage calculation based on lost microingredient sales would also be appropriate.