United States: Navigating Between The "Hypothetical Negotiation" And Real World Facts In Proving Patent Damages

Last Updated: August 18 2015
Article by Jeanne E. Irving

While there are many differences between patent cases and other complex commercial litigation, one notable distinction is the use of a "hypothetical" transaction to prove patent damages.

As a remedy for infringement of its patent, a patentee is entitled to "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."  35 U.S.C. § 284.  A reasonable royalty is generally calculated by multiplying two separate and distinct amounts: (1) the royalty base, or the revenue pool implicated by the infringement; and (2) the royalty rate, or the percentage of that pool adequate to compensate the plaintiff for the infringement.  Cornell Univ. v. Hewlett-Packard Co., 609 F. Supp. 2d 279, 286 (N.D.N.Y. 2009).

Although not the exclusive method for doing so, the commonly used construct for proving a reasonable royalty for the infringer's use of the invention – a construct that has been endorsed by case law for decades – is a "hypothetical negotiation" in which the parties would have agreed to license the asserted patent just before infringement began.

Case law provides certain rules applicable to the hypothetical negotiation.  For example, in the hypothetical negotiation, the asserted patent claims are deemed to be valid, enforceable, and infringed by the product or service that is the subject of the litigation (the "accused product"), and the parties are assumed to be a willing licensor and willing licensee acting reasonably in reaching an agreement.  Lucent Techs., Inc. v. Gateway, Inc., 580 F.3d 1301, 1324-1325 (Fed. Cir. 2009); Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1120 (S.D.N.Y.1970).

Complicating the use of a fictitious transaction as the basis for damages is the need to imbue the hypothetical negotiation with real world data grounded in the facts of the case because, in a number of aspects, real world business practices do not match up with the rules applicable to the hypothetical negotiation.

This dichotomy can arise when parties use "comparable licenses" from the real world as evidence of the "hypothetical license" that would have resulted from the hypothetical negotiation.  Courts have long recognized that real world licenses of comparable technology – and particularly actual licenses of the patents-in-suit – may provide highly probative evidence of the value of the patented invention.  LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 79 (Fed. Cir. 2012); Georgia- Pacific, 318 F. Supp. at 1120.  In negotiating real world patent licenses, however, parties generally do not act under the same constraints applicable to the hypothetical negotiation.  Accordingly, "[p]rior licenses . . . are almost never perfectly analogous to the infringement action."  Ericsson, Inc. v. D-Link Sys., 773 F.3d 1201, 1227 (Fed. Cir. 2014).

The objective of real world and hypothetical licenses is the same: that the patentee be paid for the value contributed by the features covered by the patent, but not any value attributable to other aspects of the product. However, an example of a common distinction between real world and hypothetical licenses is the treatment of the royalty base to which the royalty rate is applied.  Real world licenses often apply a royalty rate to the entire sales price of (or profit from) the licensee's product.  Rather than undertaking the daunting task of determining the amount of revenue directly attributable to the technology covered by the patent to be licensed, for the purposes of applying a royalty rate solely to that portion of the product's revenue, real world licensing parties usually choose a royalty rate small enough so that the resulting royalty paid reflects only the value perceived to be provided by the patent.  Ericsson, 773 F.3d at 1228 ("licenses are generally negotiated without consideration of the [entire market value rule]").  Using the sales price of an entire product as the royalty base for a running royalty to be paid over time also has the obvious business advantages of being readily ascertainable and, if necessary, auditable by the licensor.

In the hypothetical negotiation, however, it is generally not permissible to use as the royalty base the whole sales price – or "entire market value" – of the accused product unless the patented feature drives market demand for the product or substantially creates the value of the component parts.  Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292, 1318 (Fed. Cir. 2011).  Instead, the patentee is expected to present real world evidence that apportions the value that the patented technology contributes to the accused product, separate and apart from the value of features not covered by the patent-in-suit. See Garretson v. Clark, 111 U.S. 120, 121 (1884). 

The Federal Circuit hears all appeals in patent infringement cases.  Historically, that Court's position on the challenges presented by the apportionment requirement could be summarized as sympathetic, if not particularly forgiving.  The Court has readily acknowledged the difficulty of accomplishing the apportionment task, and the reality that it will typically involve approximation and uncertainty.  Ericsson, 773 F.3d at 1232, n.9; VirnetX, Inc. v. Cisco Sys., 767 F.3d 1308, 1328 (Fed. Cir. 2014); LaserDynamics, 694 F.3d at 66.  "Determining a fair and reasonable royalty is often . . . a difficult judicial chore, seeming often to involve more the talents of a conjurer than those of a judge."  Fromson v. Western Litho Plate & Supply Co., 853 F.2d 1568, 1574 (Fed. Cir. 1988).  Nevertheless, as to the fine line between the hypothetical negotiation and the real world, the Court has stated that, "a reasonable royalty analysis requires a court to hypothesize, not to speculate." ResQNet.com, Inc. v. Lansa, Inc., 594 F.3d 860, 869 (Fed. Cir. 2010). While founded on a hypothetical negotiation, "[a] damages theory must be based on sound economic and factual predicates."  LaserDynamics, 694 F.3d at 67 (internal quotations omitted).

In addition to recognizing the difficulty of apportionment, the Federal Circuit acknowledges that apportioning the royalty base to include only the value of the patented features is not the only way to ensure that a patent damages award provides a reasonable royalty only for the patented technology.  The Court concedes that, as a mathematical matter, a reasonable royalty can be accurately calculated using the entire sales price of a product if (like in the real world) it is balanced out by using a small enough royalty rate.  Ericsson, 2014 U.S. App. LEXIS 22778, at *54.

However, mathematical accuracy is not the sole objective of the entire market value rule.  That rule also serves "an important evidentiary principle," id., i.e., to avoid improperly influencing a jury to wrongly compensate the patentee for non-infringing components of the product by exposing the jury to large revenue figures representing the entire market value of accused products.  The Federal Circuit has expressed the concern that using a product's entire market value as a royalty base "cannot help but skew the damages horizon for the jury," Uniloc, 632 F.3d at 1320, and "make a patentee's proffered damages amount appear modest by comparison."  LaserDynamics, 694 F.3d at 68.

Relying on this rule, some accused infringers have sought to exclude damage testimony that incorporated references to real world licenses that were based on end products rather than the patented features of those products.  These defendants have argued that the inclusion of those licenses in the damage analysis violates the entire market value rule.

In December 2014, the Federal Circuit rejected that argument.  Instead, the Court found that exclusion of such real world licenses did not strike the appropriate balance between the benefit of real world evidence of the invention's worth in the marketplace and the evidentiary principle behind the entire market value rule.  In so doing, the Court affirmed that real world licenses "in which royalties were hypothetical negotiation when proper adjustments are explained to the jury.  Ericsson, 773 F.3d at 1227-1228. 

In Ericsson, the patentee advanced a per unit royalty rate consistent with comparable licenses that the patentee had entered into with third parties for a group of patents that included the patents-in-suit.  The patentee argued that its damages expert's analysis included steps to isolate the value of the patents-in-suit from any other patents covered by the real world licenses he referenced, and therefore properly apportioned any damages calculations based on those licenses to account for the value of the patents at issue.  Id. at 1225.

In seeking to exclude the damages testimony, the accused infringers argued that the testimony violated the entire market value rule because the damages calculations were, in part, based on licenses which were themselves tied to the entire value of the licensed products, even though the patents-in-suit related to only portions of those products.  Id. at 1225.

The Federal Circuit disagreed, concluding that, in light of the steps that the patentee's expert had taken to isolate the value of the patents-in-suit from the other patents in the comparable licenses, the patentee's damages testimony violated neither the rule requiring apportionment, nor the evidentiary principle demanding an "appropriate balance between the probative value of admittedly relevant damages evidence and the prejudicial impact of such evidence caused by the potential to mislead the jury into awarding an unduly high royalty."  Id. at 1227.

The Ericsson decision demonstrates the practical reality that, in navigating between the real world and the hypothetical negotiation, it's preferable not to let the perfect be the enemy of the good.  Where real world licenses predicated on the value of a multi-component product are used to inform the hypothetical negotiation, with appropriate evidence apportioning the revenue from those licenses to the patents-in-suit, they need not be excluded under the entire market value rule because, as the Federal Circuit acknowledged, a contrary rule would often make it impossible for a patentee to utilize real world license-based evidence.  Id. at 1228.

Jeanne E. Irving is a principal and complex commercial litigator at McKool Smith Hennigan, P.C. in Los Angeles, and is a member of the Board of Governors of the Los Angeles Chapter of the ABTL.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions