March 01, 2011

Over the past year or so, we have seen the U.S. Court of Appeals for the Federal Circuit (“the Court”) repeatedly set aside reasonable royalty related damages awards in patent cases.

September 2009 – Lucent v. Gateway (“Lucent”)2

  • The Court set aside a $358 million damage award. The Court found the evidence to be insufficient to support the jury’s verdict, in large part, because the licenses underlying the plaintiff’s damage award were deficient.

February 2010 – ResQNet v. Lansa (“ResQNet”)3

  • The Court set aside a damage award for more than a half million dollars. Similar to Lucent, in ResQNet the Court found that licenses underlying the damage award were deficient and, as a result, there was insufficient support for the royalty rate on which the damage award was based.

June 2010 – Wordtech v. Integrated Network Solutions (“Wordtech”)4

  • The Court set aside the quarter million dollar lump-sum royalty awarded by the jury. Again, the Court found that the evidence presented at trial did not support the damage award. Evidence related to comparable license agreements either lacked sufficient detail to provide a basis for comparison or involved royalty rates so low that they could not support the damage award.

This trend was broken in November of 2010 when the Court ruled against the defendants’ appeal of the damage award in Finjan, Inc. v. Secure Computing Corp., et al. (“Finjan”).5 This article summarizes the Court’s view on the damages related issues in Finjan and highlights differences between Finjan, Lucent, ResQNet, and Wordtech that enabled the damages award to be upheld.

Case Background

At issue in Finjan were three patents related to proactive scanning technology for computer security. Finjan, Inc. (“Finjan”) filed suit against the defendants, alleging they sold both software and hardware products which utilized the patented technology. The defendants sold three accused security products: 1) a downloadable software product called “Webwasher;” 2) a “Webwasher” hardware appliance which contained the software; and 3) a “Cyberguard TSP” hardware appliance that also contained the software.

Each of the products contained source code for eight software modules. Three of those modules offered proactive scanning functionality, in addition to other features. All eight modules were locked when the products were sold and required a customer to purchase software keys to activate each individual module.

Finjan alleged direct infringement by the defendants when the defendants tested and sold the accused products. At trial, the jury agreed with Finjan, finding that defendants willfully infringed all of the asserted claims, either literally or under the doctrine of equivalents.

Finjan put forth a damages expert who opined to damages totaling $10.1 million based on a reasonable royalty damages theory. Finjan’s expert concluded that it was entitled to an 18% royalty on all software sales and an 8% royalty on all hardware (appliance) sales. He arrived at these royalty rates by considering the Georgia-Pacific factors.6 Furthermore, he specifically utilized an income approach whereby he calculated the defendants’ operating margin on the products and then opined that one-third of the margin should be apportioned to the patent holder as reflected in Table 1 below.

Applying the respective royalty rates to accused revenues, Finjan’s damages expert concluded that reasonable royalties amounted to $10.1 million.

The defendants’ expert opined to a much lower damages value. He calculated $663,000 in damages by applying a 4% royalty rate to a royalty base of approximately $16.6 million.

The jury ultimately awarded Finjan damages totaling $9.18 million as reflected in Table 2 below.

Subsequent to the verdict, the defendants filed motions for a Judgment as a Matter of Law and a new trial, which the district court denied citing that “a reasonable jury could accept or reject either parties’ take on the evidence, including the conflicting expert testimony in this case.”7 This denial was subsequently appealed to the Court. The defendants’ arguments and the Court’s opinions are discussed below.

Georgia-Pacific Factors 1 & 2

Georgia-Pacific Factors 1 & 2 call for the consideration of existing license agreements in determining a reasonable royalty. Specifically, Factor 1 addresses the consideration of prior agreements in which the licensor licensed the patents in suit, while Factor 2 addresses the consideration of prior agreements in which the licensee licensed patents comparable to the patents in suit.

In Finjan, the defendants argued that the jury failed to properly consider Georgia-Pacific Factor 1 in arriving at its $9.18 million award. The defendants identified one agreement, a license between Finjan and Microsoft (“the Finjan-Microsoft License”) whereby Microsoft received a worldwide license to Finjan’s complete patent portfolio for a lump sum fee of $8 million. The defendants argued that the jury award of $9.18 million for the defendants’ use of only three patents for a little more than two years was excessive and not supported by the fact that Microsoft paid a lesser amount and received unlimited use of all Finjan’s patents for the remaining life of those patents.

In making this argument, the defendants may have been expecting the Court to rule as it did in Lucent, ResQNet and Wordtech where the Court set aside damage awards, in part, because they were not supported by evidence related to past license agreements. If so, the defendants failed to recognize certain important elements and differences from those cases.

In the present case, Finjan’s damages expert relied primarily on an income approach to determine his royalty rate whereas in the other cases before the Court, the plaintiffs’ experts used a market approach, relying primarily on comparable license agreements. Because Finjan’s expert’s royalty opinion was not derived from the Finjan-Microsoft License, he did not attempt to account for or explain differences in the economic circumstances of the parties to the Finjan-Microsoft License vis-à-vis the hypothetical Finjan-Secure license. For example, he made no attempt to assess the value Microsoft expected to receive from its license with Finjan or explain how that value compared to the benefit the defendants in the present case would have expected to receive in the hypothetical negotiation with Finjan. This, or a similar analysis, may have been necessary to establish a basis for comparing the license agreements if Finjan’s damages expert intended to use the Finjan-Microsoft License to support his royalty theory. Likewise, for the defendants to use the Finjan-Microsoft License to support their argument that damages were excessive, they would have had to complete a similar analysis in order to establish a basis for comparing the two agreements. They completed no such analysis; therefore, the Finjan-Microsoft License was of little or no probative value.

By comparison, in Lucent, the plaintiff argued that the $358 million lump sum award was supported by four running-royalty license agreements. The Court disagreed, indicating that there was an insufficient basis upon which to draw such a conclusion. The Court stated that

[C]ertain 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 [or vice versa], however, some basis for comparison must exist in the evidence presented to the jury.8

In Lucent, the plaintiffs’ arguments that the damages were supported by past licenses failed because they failed to establish a basis for comparing the lump-sum and running royalties. Similarly, in Finjan, the defendants’ arguments that the damages were not supported by a past license also failed because they failed to establish a basis for comparing the circumstances of the past license and the hypothetical license.

Additionally, as Finjan’s damages expert pointed out, Finjan received more than just $8 million from the Microsoft License. Finjan also received certain intangible benefits. According to Finjan’s damages expert, Finjan felt it was receiving “a fantastic endorsement of their company and their technology” because along with the $8 million payment, Microsoft: 1) promised to include Finjan in a conference where they would be featured side by side; 2) promised to participate together in a Webinar with Finjan; and 3) allowed Finjan to issue press releases to communicate the prestige of Finjan’s association with this Microsoft investment. The defendants did not consider the value of these intangible benefits.

Georgia-Pacific Factors 10 & 13

Georgia-Pacific Factors 10 & 13 relate to the nature of the patented invention and the portion of the realizable profit that should be credited to the invention.

The defendants argued that the profits Finjan’s damages expert used in calculating his reasonable royalty damages resulted from products which included eight software modules, of which only three involved the technology at issue related to proactive scanning. Upon considering Georgia-Pacific Factors 10 & 13, the defendants argued that if such profits were to be used in the royalty base, the royalty rate should be reduced to properly reflect the fact that the technology at issue comprised only a subset of the features included in the overall products.

In Lucent, the Court overturned damages, in part, due to Georgia-Pacific Factors 10 & 13. The Court found that the patented invention at issue in Lucent was but “a tiny feature” of a larger product, sales of which comprised the royalty base. The Court also indicated that the little evidence that was presented related to the portion of the larger product’s profit that should be credited to the invention.

The circumstances in Finjan were quite different. In Finjan, both experts actually testified to the significance of the invention to the product. Finjan’s damages expert stated that “proactive scanning was ‘fundamentally important to the product….’”9 The defendant’s damages expert testified that it was important and said the technology “was perceived as the next wave….”10 Additional evidence was presented in the form of documents that further corroborated and emphasized the importance of the technology.

In Lucent, the Court found that the evidence presented was insufficient for the jury to deduce the portion of the profit that should be credited to the invention. Based, in part, on this reasoning, the Court overturned the damage award. Conversely, in Finjan, the Court found the evidence presented to be sufficient such that “the jury could infer that a substantial fraction of the accused products’ profits stemmed from proactive scanning.”11

Georgia-Pacific Factors 8 & 11

The final two Georgia-Pacific Factors addressed in the appeal of the Finjan award concern issues distinct from those addressed in Lucent, ResQNet or Wordtech.

In Finjan, the defendants took issue with numerous assumptions and steps employed by the plaintiff’s damages expert in addressing Georgia-Pacific Factor 8. This factor calls for the consideration of the established profitability of the product made under the patent, its commercial success, and its current popularity.

Finjan’s damages expert’s assessment of this factor involved first determining the operating profit margins the defendants earned on the accused software and hardware sales and then concluding appropriate reasonable royalty rates by apportioning part of those profit margins to Finjan. His consideration of this factor ultimately provided the basis for his damages opinion.

On appeal, the defendants challenged five particular issues in Finjan’s damages expert’s assessment of Georgia-Pacific Factor 8. Defendants claimed:

1| He relied on companywide profit margins as opposed to profit margins specific to the accused products

2| Adjustments he made to gross profits were unrealistic

3| He ignored a report identifying gross profit margins that if used would have resulted in lower damages

4| He relied on financial data for years which were irrelevant to the hypothetical negotiation

5| His division of profits was arbitrary

Although the Court addressed each of the five issues individually in its opinion, it made a common point with regard to each: although the defendants and their expert disagree with Finjan’s damages expert on these issues, Finjan’s damages expert presented reasonable explanations to the jury for the choices he made. The Court refused to overturn the damage award based on these arguments, stating that “[i]n short, both parties’ positions on profits were based on evidence and reasoned expert opinion, and we cannot second-guess the jury’s independent views of either.”12

Georgia-Pacific Factor 11 relates to the extent to which the infringer made use of the invention and any evidence probative of the value of that use. The defendants argued that in determining the damage award, the jury ignored the fact that not all purchasers of the accused products enabled the proactive scanning features. They claimed that “if no users activated modules containing proactive scanning, no revenue for that product was properly attributable to the patented invention.”13

The Court, once again, found the defendants’ argument unconvincing. In particular, they point out that defendants appear to have confused use by customers with use by infringers. Georgia-Pacific Factor 11 specifically relates to the extent that infringers made use of the invention and in this case the accused direct infringers are the defendants, not the customers. The Court pointed out that since the proactive scanning technology was incorporated in all of the accused products the defendants’ use “encompassed all of their sales, regardless of customer activation.”14

Summary/Conclusion

In recent cases, the Court has been taking a position on damages issues which puts a greater responsibility on the parties to provide more detailed information and more rigorous analysis to support its damages theory. Finjan continues in that vein, but emphasizes the importance of having reasonable and well supported explanations of how the underlying facts relate to the damage opinion. Finjan is one example of how the damages expert can mitigate the risk that the damages awards could be overturned upon appeal.

1 It appears that Finjan’s damages expert used the 25% Rule of Thumb approach to arrive at his royalty opinion. Based on the Court’s decision in Uniloc USA, Inc., et. al. v. Microsoft, which was decided subsequent to the Finjan decision, the court now holds that the 25% Rule of Thumb is a fundamentally flawed tool for determining baseline royalty rate in a hypothetical negotiation.

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 Networks Solutions, 609 F.3d 1308 (Fed. Cir. 2010).

5 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197 (Fed. Cir. 2010).

6 Georgia-Pacific Corp. v. United States Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970).

7 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197, 1208 (Fed. Cir. 2010).

8 Lucent v. Gateway, 580 F.3d 1301, 1330 (Fed. Cir. 2009).

9 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197, 1211 (Fed. Cir. 2010).

10 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197, 1211 (Fed. Cir. 2010).

11 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197, 1211 (Fed. Cir. 2010).

12 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197, 1211 (Fed. Cir. 2010).

13 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197, 1211 (Fed. Cir. 2010).

14 Finjan, Inc. v. Secure Computing Corp., 626 F3d 1197, 1211 (Fed. Cir. 2010).