United States: A New Life for Prior Settlement Agreements in Proving a Reasonable Royalty Rate?

Since 1889, the law has accepted the view that licensing rates agreed to as part of settling a patent infringement action do not provide competent evidence of the value of a patent for determining a royalty rate to apply in later cases. For example, in Rude v. Westcott, the Supreme Court instructed:

Consequently, in today's patent litigation, courts often exclude evidence of license rates proposed or accepted in settling other infringement litigation involving the same patent.² Although often excluding from trial such settlement agreements, some courts will still allow discovery concerning settlement agreements.³

Two recent opinions from the Eastern District of Texas, Tyco Healthcare and DataTreasury, both purportedly relying on ResQNet.Com, Inc. v. Lansa, Inc., 594 F.3d 860, 872 (Fed. Cir. 2010), may be signaling a shift in the treatment of license rates contained in settlement agreements. Before addressing these opinions, however, it is helpful to discuss the relevant aspect of ResQNet. In ResQNet, the Federal Circuit, vacated a damage award based on 12.5% royalty rate. The district court had allowed the patentee to support the 12.5% rate with evidence of royalty rates of 25-40% charged by the patentee in "re-bundling" agreements. In vacating the damages award, the Federal Circuit held that because the "re-bundling" agreements concerned services and other subject matter unrelated to the asserted patent, the agreements did not provide competent evidence of a royalty rate the parties would have agreed to in a hypothetical negotiation for the asserted patent.⁴ As an additional point for showing why the 12.5% royalty rate lacked evidentiary support, the Federal Circuit noted that the only evidence in the record that actually appeared to address the value of the patented technology were two settlement agreements. One agreement set forth a lump-sum royalty while the other provided for an on-going royalty rate "averaging substantially less than the 12.5% of revenues."⁵ Given that the settlement agreements addressed the patented technology, while the "re-bundling" agreements did not, the Federal Circuit characterized the settlement agreements as "the most reliable license in this record." (Emphasis added).⁶ However, the court quickly pointed out that "litigation itself can skew the results of the hypothetical negotiation."⁷ Without addressing further the use of settlement agreements in proving a reasonable royalty, the Federal Circuit remanded to the district court to redo the damages analysis. Providing instructions for the district court to follow on remand, the Federal Circuit stated that during the remand, the district court "should not rely on unrelated licenses to increase the reasonable royalty rate above rates more clearly linked to the economic demand for the claimed technology."⁸

Relying on ResQNet, Judge Ward, in Tyco Healthcare Gp. LP v. E-Z-EM, Inc., 2010 WL 774878, *2 (E.D. Tex. Mar. 2, 2010), addressed a motion to compel discovery of a settlement agreement the accused infringer had with another patentee for the accused product. In a characterization that, unfortunately, seems easily subject to being misconstrued, Judge Ward characterized ResQNet as stating that "prior license agreements that result from litigation can be the 'most reliable' to the hypothetical negotiation damages analysis." Id. (emphasis added). He then stated that a "related settlement agreement, where it exists, may be central to the fact-finder's determination of damages using a hypothetical negotiations analysis." Id. Noting ResQNet's statement that litigation can skew the rate in a settlement agreement, Jude Ward further instructed that "the parties are entitled to show whether and to what extent the rate from a prior license agreement is the result of a compromise or reflects a desire to avoid litigation." Id. Judge Ward concluded, therefore, that:

Id. Accordingly, Judge Ward granted the motion to compel the accused infringer to produce evidence related to its prior settlement negotiations with a third party patentee.⁹

As noted above, the Federal Circuit in ResQNet only stated that, in the context of the particular record before it, the settlement agreements were the most reliable evidence because the other evidence simply did not relate to the patented technology. In this sense, Judge Ward's statement that settlement agreements can be the most reliable is technically accurate due to the unique facts of ResQNet. But Judge Ward's statement that settlement agreements "may be central to the fact-finder's determination of damages using a hypothetical negotiations analysis," is not supported by ResQNet. The Federal Circuit did not announce a new rule in ResQNet that settlement agreements are the "most reliable" of all possible evidence that may factor into a reasonable royalty analysis, and therefore are always admissible, and always discoverable. Indeed, that would contradict prior statements from the court that "[a] royalty at which a patentee offers to license his invention, particularly when coupled with a claim of infringement, is not necessarily the same rate as that upon which a hypothetical willing licensee and willing licensor would agree."¹⁰

The same day that Judge Ward issued Tyco Healthcare, Judge Rader, a member of the per curiam panel that authored ResQNet, sitting by designation as a trial judge in the Eastern District of Texas stated in IP Innovation L.L.C. v. Red Hat, Inc., 2010 WL 986620 (E.D. Tex. Mar. 2, 2010), that license agreements negotiated outside the context of litigation are the "appropriate touchstone" of a hypothetical negotiation analysis. Id. at *3. In IP Innovation, Judge Rader struck the patentee's damages expert's testimony for being unreliable. One of Judge Rader's criticisms of the expert's analysis focused on the expert ignoring in his analysis license agreements the prior owner of the patent had with other third parties. The expert ignored the prior license agreements because they occurred ten years before the date of the hypothetical negotiation.¹¹ Commenting on the relevance of these prior agreements, Judge Rader noted "[a]t least two of these agreements were entered into outside of the context of litigation and thus appropriate as touchstones for determining the appropriate royalty rate in this case." Id. Even though the agreements were old, Judge Rader instructed that "these licenses are far more relevant than the general market studies on which Mr. Gemini primarily relied in his expert report. A credible economic approach might have tried to account for the passage of time since the 1990's agreements on the patents in this case, rather than reject them out of hand." Id. In focusing on the only two license agreements that were noted as being negotiated "outside of the context of litigation," and paying no attention to the other agreements (presumably because they involved litigation), Judge Rader's view suggest that the Federal Circuit did not intend to alter the damages law regarding the relevancy of settlement agreements in a hypothetical negotiation.

Nonetheless, following Tyco Healthcare, and not mentioning IP Innovation, Judge Folsom, two days later in DataTreasury Corp. v. Wells Fargo & Co., 2010 WL 903259, *2 (E.D. Tex. Mar. 4, 2010), denied an accused infringer's motion in limine seeking to exclude evidence of a royalty rate offered to settle a case. Judge Folsom held that "[i]n light of ResQNet, litigation-related licenses should not be excluded..." Id. at *2. Instead, "Defendants' concerns about the reliability of litigation-related licenses are better directed to weight, not admissibility." Id.

Tyco Healthcare and DataTreasury may be signaling a shift in the use of royalty rates proposed or accepted in settlement agreements. ResQNet shows that there may be special circumstances where settlement agreements merit some consideration in a reasonable royalty analysis. But ResQNet has not transformed the analysis by making settlement agreements the "central fact" of a hypothetical negotiation in the way that Tyco Healthcare and DataTreasury appear to do. Even though Tyco Healthcare and DataTreasury may arguably be based on an incorrect reading of ResQNet, now that the cat is out of the bag, the use of settlement agreements in setting a reasonable royalty will likely attract greater attention until the Federal Circuit clarifies under what circumstances, if any, these agreements should be considered in a reasonable royalty damages analysis. Litigants should prepare accordingly.

About the Author

Robert A. Matthews, Jr. provides patent-law consulting services to corporate counsel and trial counsel. Specifically, he helps counsel analyze and brief the myriad of substantive and procedural legal issues arising in patent infringement litigations. Matthews authors the Annotated Patent Digest, an eight-volume patent treatise published by West and available on Westlaw, the Patent Jury Instruction Handbook, and the monthly newsletter Patent Happenings®. Matthews has assisted clients with patent matters before the U.S. Supreme Court (KSR and Bilski), the Federal Circuit, the ITC and numerous federal district courts. Further information on the patent-law consulting services Matthews offers, plus a collection of patent-litigation resources, can be found at www.MatthewsPatentLaw.com.

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Footnotes

^{1.Rude v. Westcott, 130 U.S. 152, 164 (1889). Accord Cornely v. Marckwald, 131 U.S. 159, 161 (1889). Rude has been interpreted as prohibiting a settlement agreement to serve as evidence of an established royalty rate. See Hanson v. Alpine Valley Ski Area, Inc., 718 F.2d 1075, 1078-79 (Fed. Cir. 1983); Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152, 1164 n.11 (6th Cir. 1978). Thus, whether a royalty rate in a settlement agreement can be relied on as a factor to consider in determining a reasonable royalty rate under the hypothetical negotiation model arguably is not prohibited by Rude.}

^{2.See generally, Robert A. Matthews, Jr., Annotated Patent Digest [hereinafter APD] § 30:82 Established Rate May Not be Based on Impact of Royalties Paid in Settlement; § 30:101 —Rate Proposed in Settlement Negotiations May Be Inadmissible; see also § 44:94 Settlement Negotiations Under Rule 408.}

^{3.See generally, APD § 41:21 Relevancy of Licensing Agreements; § 41:62 Production of Patentee's Licensing Documents; see also § 42:192 Settlements and Related Negotiations; § 44:85 Prelitigation License Offers; § 44:94.50 Rule 408 as a Basis to Deny Discovery.}

^{4.See, 594 F.3d 860, 869-73 (criticizing the use of the re-bundling agreements in part because "none of these licenses even mentioned the patents in suit or showed any other discernible link to the claimed technology").}

^{5.Id. at 870.}

^{6.Id. at 872.}

^7.Id.

^{8.Id. at 872-73.}

^{9.Judge Ward also rejected the contention that a "settlement privilege" as set forth in Goodyear Tire & Rubber Co. v. Chiles Power Supply, Inc., 332 F.3d 976, 980-983 (6th Cir. 2003) applied to bar discovery. In his view, ResQNet overruled any applicability that Goodyear may have had. Id. See generally, APD § 42:192 Settlements and Related Negotiations (discussing cases addressing "settlement privilege").}

^{10.American Original Corp. v. Jenkins Food Corp., 774 F.2d 459, 464 (Fed. Cir. 1985). See also Snellman v. Richo Co., Ltd., 862 F.2d 283, 289 (Fed. Cir. 1989) (proper to admit evidence of settlement agreement between plaintiff and third party where royalty would only become effective if appellate litigation ultimately resulted in infringement liability to the third party because the agreement was not an attempt to resolve litigation); Studiengesellschaft Kohle v. Dart Indus., Inc., 862 F.2d 1564, 1572 (Fed. Cir. 1988) (proper to consider patent holder's post-infringement settlement with third party where patent held valid in litigation and all that remained for parties was an accounting, and therefore settlement was not reached under a threat of litigation but in the context of attempting to value a valid patent).}

^{11.See generally, APD § 30:86 Time Period for Assessing Circumstances Relevant to Setting the Royalty Rate.}

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