March 01, 2010

The first two factors enumerated in Georgia-Pacific Corp. v. U.S. Plywood Corp. (“Georgia-Pacific”)1 point practitioners to consider royalties received by the patentee from existing licenses as well as assess the rates paid by the licensee for the use of other patents comparable to the patents-in-suit. In the past six months, the United States Court of Appeals for the Federal Circuit (“the Court”) has set aside two damage awards because of the reliability and sufficiency of evidence supporting such licenses.

In particular, this past September, the Court set aside a $358 million damages award in Lucent v. Gateway (“Lucent”)2 because the evidence was insufficient to support the jury’s verdict, in large part, because the licenses underlying the plaintiff’s damage award were deficient. More recently, in ResQNet v. Lansa (“ResQNet”),3 the Court also set aside an award that was based, in large part, on license agreements because the award of a 12.5% royalty was based on speculative and unreliable evidence. Specifically, the ResQNet Court found that the licenses underlying the plaintiff’s damage award were deficient.

Since license agreements can form an important part in determining a reasonable royalty, and the fate of the award can hinge on the sufficiency of evidence supporting those agreements, what evidence is necessary in the eyes of the Court in order to rely upon such license agreements? Also, what constitutes a comparable license agreement and how much evidence is necessary to establish comparability?

This article summarizes the Court’s view on these important issues based on its opinions in Lucent and ResQNet.

1. Royalties received by the patentee from existing licenses (i.e., Georgia-Pacific Factor 1)

The purpose of Georgia-Pacific Factor 1 is to determine the extent to which there is an established royalty for the licensing of the patents-in-suit. A royalty is generally considered to be an established rate if the licensor has extended licenses to numerous third parties in the normal course of business at the same royalty rate. Absent an established royalty, this factor also considers the extent to which actual royalties received from the licensing of the patents-in-suit are nonetheless instructive in determining a reasonable royalty.

In ResQNet, the district court adopted the royalty rate of ResQNet’s damages expert in setting damages. ResQNet’s damages expert based his starting point in the analysis of the reasonable royalty on the first factor of the Georgia-Pacific framework – royalties received by the patentee from existing licenses. As such, the Court’s opinion focused on the reliability of the licenses considered in connection with Georgia-Pacific Factor 1 that formed the basis for the damages expert’s opinion. In particular, the Court stated that “[t]he first Georgia-Pacific factor, which [ResQNet’s damages expert] found to be controlling and which the district court in turn adopted, must consider licenses that are commensurate with what the defendant has appropriated.”4

a. Reliance on bundled agreements

In reaching his opinion that a reasonable royalty should be 12.5%, ResQNet’s damages expert relied largely on seven ResQNet licenses, five of which were bundled agreements and the remaining two were settlement agreements. ResQNet’s damages expert explained that the 12.5% royalty was significantly lower than the royalties in the bundled licenses, and higher than the royalty in one of the litigation settlements.

As it pertained to the bundled agreements, the Court found that those agreements:

had no relation to the claimed invention. [The] five re-branding or re-bundling licenses (hereinafter, the “re-bundling licenses”) furnished finished software products and source code, as well as services such as training, maintenance, marketing, and upgrades, to other software companies in exchange for ongoing revenue-based royalties. [Those] companies obtained the right to re-brand ResQNet’s products before resale or bundl[ing those] products into broader software suites…Notably, none of [those] licenses even mentioned the patents in suit or showed any other discernible link to the claimed technology.”5

As such, ResQNet’s damages expert was criticized for relying on the bundled agreements. In the eyes of the court, he offered

“little or no evidence of a link between the re-bundling licenses and the claimed invention...” [He] “did not even attempt to show that these agreements embody or use the claimed technology or otherwise show demand for
the infringed technology. In simple terms, the [patent-in-suit] deals with a method of communicating between host
computers and remote terminals – not training, marketing, and customer support services. The re-bundling licenses simply have no place in this case.”6

In addressing the district court’s need to reconsider the reasonable royalty calculation on remand, the Court explicitly stated that “the trial 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.”7 (emphasis added)

Judge Newman, in her dissent, states the majority opinion

create[s] a new rule whereby no licenses involving the patented technology can be considered, in determining the value of the infringement, if the patents themselves are not directly licensed or if the licenses include subject matter in addition to that which was infringed by the defendant here…8

Judge Newman continued, stating that her “colleagues hold that it is reversible error, as a matter of law, to have considered [the re-bundling] licenses at all.”9

Since the re-bundling agreements did not reflect the economic demand for the claimed technology, there was no evidence to establish that the licenses offered any insight as to what the parties in the hypothetical negotiation would have paid for a patent license for the claimed invention. As such, they were deemed irrelevant.

b. Reliance on agreements arising from litigation

The Court also used this occasion to address the reliability of settlement agreements in establishing a reasonable royalty from the hypothetical negotiation. As mentioned previously, two of the licenses in ResQNet had been entered to settle litigation.

The district court observed that licenses entered during litigation are not necessarily comparable to licenses negotiated between a willing licensor and licensee before infringement has begun. The district court also observed that in litigation the patent is already at risk.

In reply, the Court acknowledged that while on other occasions, it “has acknowledged that the hypothetical reasonable royalty calculation occurs before litigation and that litigation itself can skew the results of the hypothetical negotiation … [t]his court observes … that the most reliable license in this record arose out of litigation.”10

Judge Newman in her dissent states that

This court today holds that only the royalty in the settlement agreement can be considered in the hypothetical license negotiation. This ruling, excluding all of the other considerations relevant to determining damages for a patent that has been held valid and infringed, is contrary to all precedent.11

Consequently, while settlement agreements can reflect “burdens, costs, and uncertainties” and may reflect “unique considerations,” in certain instances as in the present case, they may nonetheless be instructive in determining a reasonable royalty according to the majority opinion.12

2. Rates paid by the licensee for the use of other patents comparable to the patent in suit (Georgia-Pacific Factor 2)

In establishing the basis for setting aside the $358 million damages award in Lucent, the Court focused much of its attention on the sufficiency of evidence presented in connection with the analysis of Georgia-Pacific Factor 2 – rates paid by the licensee for the use of other patents comparable to the patent in suit.

At issue was a calendar date-picker tool found in Microsoft Outlook, Microsoft Money, and Windows Mobile, which enabled the user to select a series of numbers, corresponding to the day, month, and year, using graphical controls. Microsoft, who intervened on behalf of Gateway, generated approximately $8 billion in revenue from sales of the accused products.13

At trial, Lucent’s theory of damages was based on a royalty of 8% of sales revenue for the accused software products, and it asked the jury to award $561.9 million based on Microsoft’s infringing sales. Microsoft countered that a lump-sum payment of $6.5 million would have been the correct amount for licensing the protected technology. Based on the verdict form, the jury decided on a lump-sum award of approximately $358 million, not a running royalty.

In light of the jury’s finding, the Court was faced with determining whether substantial evidence supported a lump-sum, paid-in-full royalty of approximately $358 million for Microsoft’s indirect infringement of the patent in suit. To do that, the Court evaluated whether substantial evidence supported the jury’s implicit finding that Microsoft would have agreed to, at the time of the hypothetical negotiation, a lump-sum, paid-in-full royalty of approximately $358 million. Despite advocating a running royalty at trial, Lucent, in the appeal, defended the damages award, contending that
substantial evidence supported the lump-sum award of approximately $358 million.

Since little evidence was presented to support a lump sum royalty of the size awarded by the jury, the Court was left with the unmistakable conclusion that the jury’s damages award was not supported by substantial evidence, but was based mainly on speculation or guesswork. The Court made clear that “district court judges must scrutinize the evidence carefully to ensure that the ‘substantial evidence’ standard is satisfied, while keeping in mind that a reasonable royalty analysis ‘necessarily involves an element of approximation and uncertainty.”14

In its discussion of Georgia-Pacific Factor 2, the Court found that substantial evidence did not support the jury’s verdict because: 1) there was no evidence regarding the parties’ expectations of use; 2) there was no evidence explaining how a license agreement structured as a running royalty agreement was probative of a lump-sum payment; and 3) the license agreements for other groups of patents, invoked by Lucent, were created from events far different from a license negotiation to avoid infringement of the one patent at issue in the case.

a. No evidence regarding the parties’ expectations of use

One of the factors that the Court considered was whether the parties’ expected use of the patented feature supported the lump sum award. The Court noted that in connection with negotiating a lump sum royalty, parties may consider the expected usage of the invention, “because the more frequently most inventions are used, the more valuable they generally are and therefore the
larger the lump-sum payment. Conversely, a minimally used feature, with all else being equal, will usually command a lower lump-sum payment.”15

The Court found that Lucent presented:

no documentary evidence or testimony showing the parties’ expectations as to usage of the claimed method. Lucent submitted no evidence upon which a jury could reasonably conclude that Microsoft and Lucent would have estimated, at the time of the negotiation, that the patented date-picker feature would have been so frequently used or valued as to command a lump-sum payment that amounts to approximately 8% of the sale price of Outlook.16

b. No evidence explaining how a license agreement structured as a running royalty agreement was probative of a lump-sum payment

Another factor considered by the Court was whether there was sufficient evidence regarding how a license agreement structured as a running royalty agreement was probative of a lump-sum payment to which the parties would have agreed. This inquiry is premised on the fact that there are differences between a running royalty license and a lump sum license. In fact, the Court, at considerable length, enumerated “differences [that] exist between a running royalty license and a lump-sum license.”17 Recognizing those differences, the Court found that Lucent presented no evidence of how a license agreement structured as a running royalty agreement was probative of a lump-sum payment to which the parties would have agreed.

c. License agreements relied upon were of little probative value

Lastly, the Court considered the license agreements that were presented to the district court. In support of its damages opinion, Lucent relied on eight varied license agreements. The Court was clear that “it was Lucent’s burden to prove that the licenses relied upon were sufficiently comparable to sustain a lump-sum damages award of $358 million.”18 However, the Court expressed two concerns about the agreements. First, it found that some of the license agreements were radically different from the hypothetical agreement under consideration for the patent in suit. Second, the Court was unable to ascertain from the evidence presented the subject matter of the remaining agreements from which to adequately evaluate the probative value of those agreements.

i. Lump sum agreements

Only four of the eight agreements presented purported to be lump-sum agreements and were characterized as covering “PC-related patents.” The Court criticized Lucent’s reliance on such a broad class of licenses “as if personal computer kinship imparts enough comparability to support the damages award.”19 Table 1 below summarizes the lump sum licenses that were considered by the district court.

The Court stated that “Lucent had the burden to prove that the licenses were sufficiently comparable to support the lump-sum damages award” but it provided “no analysis of those license agreements, other than, for example, noting the agreement was a cross-license of a large patent portfolio and the amount paid.”22 The Court further stated that

[t]he law does not require an expert to convey all his knowledge to the jury about each license agreement in evidence, but a lump-sum damages award cannot stand solely on evidence which amounts to little more than a recitation of royalty numbers, one of which is arguably in the ballpark of the jury’s award, particularly when it is doubtful that the technology of those license agreements is in any way similar to the technology being litigated here.23

ii. Running-royalty agreements

Lucent also relied upon four running-royalty license agreements which purportedly provided substantial evidence supporting a lump-sum damages award of approximately $358 million. According to the Court,

[a] significant shortcoming of these agreements is their “running-royalty” nature, however…certain fundamental differences exist between lump-sum agreements and running-royalty agreements. This is not to say that a running-royalty license agreement cannot be relevant to a lump-sum damages award, and vice versa. For a jury to use a running-royalty agreement as a basis to award lump-sum damages, however, some basis for comparison must exist in the evidence presented to the jury. In the present case, the jury had almost no testimony with which to recalculate in a meaningful way the value of any of the running royalty agreements to arrive at the lump-sum damages award.24

Judge Newman, one of the authors of the Lucent opinion, clarified in her dissent in ResQNet that the Lucent Court “observed that ‘fundamental differences exist between lump-sum agreements and running-royalty agreements’ – not for the purpose of excluding such evidence, but to point out that such differences must be recognized.”25 (emphasis added)

Specifically, the Court concluded that the running royalty agreements put into evidence differed substantially from the hypothetical negotiation scenario involving the patent-in-suit. Table 2 below summarizes the pertinent information regarding the licenses that were considered by the district court including what was NOT presented to the district court.

Upon its review of evidence relating to these licenses, the Court concluded that there was “little evidentiary basis under Georgia-Pacific Factor 2 for awarding roughly three to four times the average amount in the lump sum agreements in evidence.”29 The Court further stated “[t]hat some licenses were cross-licenses or commuted-rate licenses – which may warrant a higher damages award – does not fill the evidentiary lacunae.”30

Conclusions

Lucent and ResQNet emphasize the need to adequately support license agreements that form the basis of any damages opinion. Otherwise, the damages award may not hold up on appeal. These cases appear to highlight the need for a more rigorous analysis of license agreements in order to support a reasonable royalty claim. As such, parties should conduct thorough discovery of these issues early in the case.

1 Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F.Supp. 1116 (S.D.N.Y.1970)

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

3 ResQNet. v. Lansa, 2010 WL 396157 (C.A.Fed. (N.Y.)).

4 Id. at *10.

5 Id. at *8.

6 Id. at *9.

7 Id. at *11.

8 Id. at *15.

9 Id. at *16.

10 Id. at *11.

11 Id. at *20.

12 Id. at *18.

13 The revenue was generated in part through Dell.

14 Lucent, 580 F.3d at 1336 (quoting Unisplay, S.A. v. Am. Elec. Sign Co. 69 F.3d 512, 517 (Fed.Cir. 1995).

15 Id. at 1327.

16 Id.

17 Id. at 1326.

18 Id. at 1332.

19 Id. at 1328.

20 Id. at 1328-9.

21 “From this information, a reasonable juror could only conclude that the IBM-Dell license agreement for multiple patents to broad, PC-related technologies is directed to a vastly different situation than the hypothetical licensing scenario of the present case involving only one patent … directed to a narrower method of using a graphical user interface tool known as the date-picker. Of course, without more information about the IBM-Dell agreement, one can only speculate about how the Dell-IBM agreement could be compared to any licensing agreement involving the [patent-in-suit].” Id. at 1328.

22 Id. at 1329.

23 Id.

24 Id. at 1329-30.

25 ResQNet, 2010 WL 396157 at *16 (quoting Lucent, 580 F.3d at 1330).

26 Lucent, 580 F.3d at 1329-31.

27 A commuted royalty is, for administrative convenience, calculated based on worldwide product revenue rather than infringing U.S. revenue.

28 It is not clear from the opinion that the rate was actually $4 per unit. The Court merely stated that “the MPEG agreement on its face supports a higher royalty rate of $4 per unit.” Lucent, 580 F.3d at 1331.

29 Id. at 1332.

30 Id.