September 01, 2010

In the past year, the United States Court of Appeals for the Federal Circuit (“the Court”) has published several opinions emphasizing the need to exercise more rigor in the analysis and quantification of damages in patent cases. In fact, in the last issue of the Stout Journal, we discussed two of those cases that dealt with the treatment of license agreements1Lucent2 and ResQNet3.

Recently, the Court published yet another opinion addressing similar issues in another patent infringement case. In Wordtech Systems v. Integrated Network Solutions (“Wordtech”), the Court held that “the verdict was ‘clearly not supported by the evidence’ and ‘based only on speculation or guesswork….’”4 Specifically, the Court found that the license agreements failed to support the damages award and that insufficient detail concerning the economics underlying the agreements was presented in order for the jury to have reasonably relied upon the agreements as a basis for their damages award. The Court therefore set aside the damages award and remanded the case for a new damages trial.

The Wordtech case, like Lucent and ResQNet, emphasizes the need for more rigorous analysis and support of the license agreements that not only form the basis for a damages award at the district court, but will also withstand the scrutiny of the Federal Circuit. So what can we learn from the Court’s latest decision addressing damages?

Background

At issue in Wordtech were three patents that share a common parent application and relate to “Programmable Self-Operating Compact Disk Duplication Systems.” Wordtech Systems Inc. (“WSI”) alleged that the defendants, Integrated Networks Solutions, Inc., (“INSC”)5 sold disk duplication devices, referred to as Robocopiers, which utilized technology taught by the patents-in-suit. At trial, the jury found that INSC willfully infringed all three of the patents-in-suit.

At trial, WSI proffered a single theory attempting to establish a reasonable royalty based on a hypothetical negotiation between the parties. WSI argued that a royalty rate of at least 12% be applied to $950,000 of infringing sales resulting in damages of at least $114,000. WSI did not offer any expert opinion, but instead relied on the testimony of its President, David Miller. It was through Miller that WSI introduced thirteen patent license agreements to support its reasonable royalty. The thirteen agreements related to rights granted by WSI to third parties for some or all of the patents-in-suit. Table 1 summarizes those thirteen license agreements.

The jury ultimately awarded WSI a lump-sum royalty of $250,000. Although requested in the verdict form, the jury did not disclose whether a running royalty was used to arrive at its lump-sum award nor did they disclose the royalty percentage or royalty per unit that may have been used to arrive at the lump-sum award.

On appeal, INSC argued that the damages award was excessive and that the license agreements that WSI introduced into evidence did not support the verdict because they reflected different economic circumstances than those in the hypothetical negotiation.

Lump-Sum Royalty Licenses Failed to Support the Damages Award

Of the thirteen license agreements proffered by WSI, only two specified lump-sum royalty payments.

  • In connection with the first agreement, WSI received $175,000 for granting nonexclusive rights to practice the technology taught by two of the three patents-in-suit as well as any related or WSI-owned patents.
  • In connection with the second agreement, WSI received $350,000 for granting nonexclusive rights to practice the technology taught by all three of the patents-in-suit.

Despite the fact that the $250,000 damages award was more than double the damages explicitly sought by WSI, it claimed in post-trial briefs that the damages award was reasonable because it was roughly the average of the two lump-sum royalty licenses ($262,500).

The Court did not agree with WSI’s reasoning and found that:

This “averaging” theory is flawed because the two lump-sum licenses provide no basis for comparison with INSC’s infringing sales. Neither license describes how the parties calculated each lump sum, the licensees’ intended products, or how many products each licensee expected to produce. Indeed, when asked if the record supplied “any idea of the volume of sales or projected sales,” [WSI’s] counsel admitted: “With the trial court, none of that was discussed.”7

The Court reasoned that additional information beyond simply a lump-sum royalty amount is necessary in order for an existing license agreement to be instructive in establishing a hypothetically negotiated running royalty. The Court illustrated its position by stating:

If [WSI’s] previous license paid $350,000 to produce one thousand devices [implying a royalty of $350 per unit], for example, INSC would not have agreed ex ante to pay $250,000 if it expected to make only fifty-six units [implying a royalty in excess of $4,400 per unit]. Thus, without additional data, the licenses offered the jury “little more than a recitation of royalty numbers.”8

Running Royalty Licenses Also Failed to Support the Damages Award

Eleven of the thirteen license agreements proffered by WSI were based on running royalties.

  • One of these agreements called for a per-unit royalty of $100-$195.9
  • The remaining ten agreements called for royalty rates of 3%-6% of the licensees’ sales.10

In Lucent, the Court found that license agreements based on running royalties could be relevant in supporting a lump-sum royalty but “some basis for comparison must exist in the evidence presented to the jury.”11

In Wordtech, The Court found no basis for comparison between the damages award and the agreement containing the per-unit royalty of $100-$195 given that the implied per-unit royalty resulting from the damages award was more than $4,400.12 Similarly, the Court found that the ten remaining agreements also failed to support the damages award. Whereas those agreements contained royalty rates ranging from 3% to 6%, the damages award implies an effective royalty rate of 26.3%.

WSI claimed that the royalty rates in the agreements ranged as high as 10%, however, the Court pointed out that rates above 6% would only result from penalties related to accounting lapses and that using such rates “distorts the record.”13 Nevertheless, even if the “distorted” rates were considered, they still would not support a hypothetically negotiated rate of 26.3%.

It is also worth noting that nearly all of the thirteen licenses were agreed to either after the threat or initiation of litigation, however, it did not appear that the Court was excluding these “settlement” agreements on that basis. The only time the topic of settlement agreements is mentioned in their opinion is when they state:

[WSI] signed several of these licenses after initiating or threatening to initiate litigation against the licensees, and “litigation itself can skew the results of the hypothetical negotiation.”14

Unsubstantiated Theories Not Posed to the Jury Cannot Be Used to Support an Excessive Damages Verdict

On appeal, WSI defended the damages verdict by arguing that it was supported by Georgia-Pacific factor 13, which considers the portion of the infringer’s profit that “should be credited to the invention as distinguished from non-patented elements.”15 WSI claimed that most, if not all, of the profit from the accused sales was attributable to the infringing software and it estimated those profits to total $800,000. Additionally, WSI postulated that a 30% or 50% split of the profits would be “reasonable” and stated that “[c]ommon sense would dictate that Miller [WSI’s president] would ask for half of the profit or a lump sum fee.”16 Based on this theory, whereby damages could amount to $240,000 assuming a 30% profit split or $400,000 assuming a 50% profit split, WSI claimed the $250,000 damages verdict was reasonable.

The Court was not persuaded by WSI’s argument and in particular its use of “unproven profit numbers” and the fact that WSI “did not pose this theory to the jury, nor explain why 50% or 30% would be reasonable.”17 The Court rejected WSI’s argument stating that “[i]nstead of providing plausible explanations for the verdict, [WSI’s] unsupported rationalizations highlight the speculative nature of the evidence.”18

Conclusion

Considering Lucent, ResQNet and now Wordtech, the Court is placing a greater responsibility on the parties to provide more detailed information concerning comparable license agreements and more rigorous analysis to support its damages theories. Although there will always be uncertainty with regard to the size and structure of damages awards levied by juries in patent infringement cases, more detailed information and more rigorous analysis should help mitigate some of the risk that damages awards levied by juries will be overturned upon appeal because they are not sufficiently supported by the evidence.

1 Bone, John R., “Court Weighs in on License Agreements Used in Support of Damages Award.” Stout Journal (Spring 2010): 89-93. Print.

2 Lucent v. Gateway, 580 F.3d 1301 (Fed. Cir. 2009).

3 ResQNet. v. Lansa, 594 F.3d 860 (Fed. Cir. 2010).

4 Wordtech v. Integrated Network Solutions, 609 F.3d 1308 (Fed. Cir. 2010) at 1319 citing Del Monte Dunes at Monterey, Ltd. v. City of Monterey, 95 F.3d (9th Cir. 1996) at 1435.

5 Integrated Networks Solutions, Inc. does business as Integrated Network Solutions Corp.

6 Brief of Appellants, 2009 WL 3183216 (C.A. Fed.).

7 Wordtech v. Integrated Network Solutions, 609 F.3d 1308 (Fed. Cir. 2010) at 1320.

8 Ibid citing Lucent v. Gateway, 580 F.3d 1301 (Fed. Cir. 2010) at 1329.

9 The Court’s opinion indicates a range for $100 to $195, however, the Brief of Appellants indicates a range of $25 to $195.

10 The Court’s opinion states “the other ten licenses stated royalty rates in the rage of 3-6% of the licensee’s sales….” However, the Brief of Appellants indicates that 6% royalty rate would only become effective if the 5.5% royalty rate payments pertaining to that specific license were not timely made for one year.

11 Wordtech v. Integrated Network Solutions, 609 F.3d 1308 (Fed. Cir. 2010) at 1320 citing Lucent v. Gateway, 580 F.3d 1301 (Fed. Cir. 2010) at 1330.

12 Verdict of $250,000 divided by 56 infringing units yields a royalty of $4,464.29 per unit.

13 Wordtech v. Integrated Network Solutions, 609 F.3d 1308 (Fed. Cir. 2010) at 1320.

14 Ibid at 1320-1.

15 Ibid at 1321 citing Georgia-Pacific v. U.S. Plywood, 318 F.Supp.1116 (S.D. NY 1970) at 1120.

16 Ibid at 1321-2.

17 Ibid at 1321.

18 Ibid at 1322.