March 01, 2014

This is one in a running series intended to highlight rulings and/or issues from the District Courts that may be relevant to the calculation of damages in intellectual property matters. While rulings from the District Courts may not establish general precedent outside of their particular district, they can involve thought-provoking issues and can also reflect how the District Courts are interpreting and responding to rulings by the Court of Appeals for the Federal Circuit (“Federal Circuit”). The goal of this article is to provide a synopsis of particular issues, rulings, and cases.

Application of the Entire Market Value Rule and Definition of the Smallest Salable Unit

In the past five years, District Courts have issued a number of key decisions that have placed significant focus on proper application of the entire market value rule (“EMVR”) in calculating patent infringement damages. Often addressed in tandem with this issue is the need to properly define the smallest salable unit of an accused technology. In Cornell v. Hewlett-Packard, for example, Chief Judge Rader instructed the patentee to utilize the “smallest salable unit approach” to apportion the royalty base.1 Under this approach, the parties decide the “smallest salable infringing unit with close relation to the claimed invention”.2 In conjunction with this framework, the Cornell Court explicitly stated that the use of the entire market value is inappropriate where the patented feature is not the basis for consumer demand for the product sold.

The Federal Circuit found similarly in LaserDynamics v. Quanta Computer, reaffirming that “in any case involving multi-component products, patentees may not calculate damages based on sales of the entire product, as opposed to the smallest salable patentpracticing unit, without showing that the demand for the entire product is attributable to the patented feature.”3 LaserDynamics also supports the idea that an apportionment may be necessary even where the accused product is the smallest salable unit. Even in cases where the smallest salable unit is still a multi-component product, the LaserDynamics Court indicated that it is appropriate to perform an apportionment if the product encompasses key non-patented features. The district courts have interpreted these rulings in several instances and applied the framework to several decisions issued in recent months.

While the LaserDynamics Court indicated that further apportionment beyond the revenue from the smallest salable unit is appropriate, this appears to be inconsistent with the order in Cornell. In the Cornell decision, Chief Judge Rader indicated that revenue from the smallest salable patent-practicing unit was the appropriate royalty base. He did not require further apportionment despite the fact that: 1) the smallest salable unit encompassed other non-patented features; and 2) no evidence was apparently offered indicating that the patented feature drove demand for even the smallest salable unit.

Four noteworthy decisions recently handed down by District Courts agreed with Defendants’ motions after finding that damages had been improperly assumed or overstated for reasons that relate to these issues:

1| Brocade Communications Systems, Inc., et al., v. A10 Networks, Inc., et al., a case from the Northern District of California, dealt with two patents describing apparatuses that improve the performance of global server load balancing and one patent describing systems and methods for providing route redundancy in communication networks. In calculating the royalty award, the jury utilized the royalty base proffered by Plaintiffs’ damages expert. In response, Defendants renewed their motion for judgment as a matter of law (“JMOL”) challenging, among other things, the sufficiency of the evidence supporting the use of the EMVR in defining the royalty base. In response, Plaintiffs argued that the products at issue represented the smallest salable units for the infringing software patents.

it believed to be the smallest salable unit. Rather, the Court indicated that the accused product has many components for which Plaintiffs do not own patents and, therefore, Plaintiffs “had to show that its patented features drove consumer demand for A10’s product before it could use all of the [revenues] A10 earned from the sale of the [accused] product as the royalty base.”4

 

Plaintiffs cited testimony from their damages expert indicating that the patented features were important and that A10 could not have sold the accused products but for those features. The Court did not find this argument to be sufficient, citing: 1) the absence of testimony by the Plaintiffs’ damages expert that the patented features drove demand for the entire product; and 2) evidence proffered by A10 indicating that its customers purchased its products for other, non-patented features. Opining that “necessity is not enough,”5 the Court vacated the jury’s royalty award and ruled that no reasonable jury could conclude that Plaintiffs met their burden to show that the patented features drove consumer demand for the accused product.

2| In Network Protection Services, LLC v. Fortinet, Inc. — also in the Northern District of California — Defendant Fortinet filed a motion to strike the expert report of Plaintiff’s expert. Fortinet contended that Network Protection Services’ (“NPS”) expert’s damages analysis improperly based royalties on the entire market value of the accused products. Plaintiff responded by arguing that its apportionment analysis, which first ascertained the smallest salable patent-practicing unit and then analyzed the proportion of product value derived from the allegedly infringing technology, was performed in accordance with the requirements of the Federal Circuit.6

To prove the patent-in-suit drives demand for the product, NPS’s expert contended that the “patent-in-suit either directly or indirectly drives demand for products…”7 and admitted that “product attributes enabled by the patented technology are not the only drivers of demand for the accused products.”8 NPS had further contended that “Lucent stands for the proposition that using the entire market value of a multi-component product is permissible ‘as long as the proportion of the product represented by the infringing feature is taken into account.’”9

The Court ruled that Plaintiff’s reliance on Lucent in its reasoning was misplaced, pointing out that in LaserDynamics the Federal Circuit used the Lucent fact pattern as an example of the high bar set by the EMVR. Accordingly, the Court ruled in favor of the Defendant, opining that the “smallest salable units” proffered by the Plaintiff “contain substantial non-accused components”10 and that “when using a multi-component product as a royalty base, even if it is the smallest salable unit, a patentee must still show that the patented feature drives demand for the entire product.”11 As a result, the Court determined that the analysis could not be presented to a jury.

3| In Rembrandt Social Media, LP v. Facebook, Inc., a case from the Eastern District of Virginia, defendant Facebook contended that, among other things, Plaintiff’s expert: 1) improperly used Facebook’s entire revenue stream as the starting point for the royalty base and that this violated the EMVR; and 2) that the expert apportioned revenue based on features not causing the alleged infringement. While the Court recognized that Plaintiff’s expert’s analysis did indeed begin with Facebook’s entire revenue stream, the calculation involved two separate apportionments to the revenue. Because EMVR applies only when an expert performs no apportionment, the Court ruled that EMVR was not implicated in this case.

The Court did, however, rule in favor of the Defendant on its second argument, ruling that Plaintiff’s expert had included revenue attributable to features not covered by the patents-in-suit and had thus claimed damages that would have more than adequately compensated for the infringement. The Court found that an additional apportionment was required, stating that “[o]f course, the smallest salable infringing unit must be the starting point for the royalty base, but the Federal Circuit has not held ‘that no further apportionment is ever necessary once the smallest salable unit is determined’.”12

4| In Dynetix Design Solutions, Inc. v. Synopsys, Inc. in the Northern District of California, Plaintiff’s expert was excluded because once he selected the smallest salable unit, he ended the analysis and, therefore, the determination of the royalty base was fundamentally flawed given that the patented feature of the smallest salable unit was just one of many patented features.13 In the case, the smallest salable unit was not smaller or any different from the entire product and, as a result, “the difficult task of determining [the] value relative to all other components of [the product] remain.”14

Conversely, two recent District Court decisions found that Plaintiffs’ experts had adequately accounted for non-patented features in their calculations of damages:

1| In Kimberly-Clark Worldwide, Inc. v. First Quality Baby Products, LLC et al., in the Middle District of Pennsylvania, Defendant filed a motion in limine to exclude Plaintiff’s expert from offering opinions or testimony, contending that the methodology employed by Plaintiff’s expert was improper in using total product revenue as the royalty base. The Court concluded that the use of total revenue was proper because the proper adjustment was considered in the royalty rate. The court cited Lucent in opining that “the base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence).”15

The Kimberly-Clark Court further cited Lucent, stating that “…even when the patented invention is a small component of a much larger commercial product, awarding a reasonable royalty based on either sale price or number of units can be economically justified.”16 The Court further noted that the prior licenses relied upon to calculate the rate had employed the same methodology, providing additional support for Plaintiff’s experts approach.17

2| In Tomita Technologies USA, LLC, et al. v. Nintendo Co., et al. in the Southern District of New York, Plaintiff’s expert used revenue from the smallest salable unit, which happened to be a product in which the patented features were “an ancillary” part. Defendants challenged this use, but the Court upheld the analysis stating that, “[Plaintiff’s expert] properly looked to the [product] itself as the ‘smallest salable unit,’ and therefore did not rely on the entire market value rule. Nintendo neither purchases nor sells components of the [product] that infringe...”18

The court further justified its ruling by pointing out that the individual components cannot practice the patent before they are assembled and programmed and the product is imported into the United States fully assembled.

Use of Nash Bargaining Solution

Since the Federal Circuit’s ruling in Uniloc officially pronounced the end of the 25% rule, some damages experts have looked to new approaches for apportioning profit between the plaintiff and defendant in the determination of a reasonable royalty. An approach that some experts have elected to use is the Nash Bargaining Solution (“NBS”). Generally speaking, the NBS is based on Game Theory and offers an explanation as to how two parties would apportion some good for which they were bargaining, assuming certain axioms.

Subsequent to Uniloc, the first opinion by a District Court relating to an expert’s use of the NBS occurred in the Northern District of California in Oracle v. Google.19 In that matter, Judge Alsup found that Plaintiff’s expert failed to: 1) adequately explain his use of the NBS; 2) tie his use of the NBS to the facts of the case; and 3) show how the axioms underlying the NBS were warranted. Moreover, Judge Alsup questioned whether any jury could follow the underlying mathematics or comprehend testimony trying to explain it. As such, he excluded any testimony based on the NBS.

In the past year, use of the NBS by damages experts has been addressed in several cases. In Gen-Probe Inc., v. Becton Dickinson & Company, Defendant filed a Daubert motion to preclude the testimony of Plaintiff’s damages expert. Defendant contended that Plaintiff’s expert based calculations on arbitrary profit splits. At deposition, the expert explained his methodology was based on a combination of real-world observation and the NBS. The Court ultimately sided with the Plaintiff, finding that the expert’s analysis was sufficiently tied to the facts of the case and that his testimony was therefore admissible.

In the Eastern District of Texas, two opinions in related matters were handed down by Judge Davis denying defendants’ motions that challenged Plaintiffs’ use of the NBS. The order in VirnetX, Inc. v. Apple, Inc. related to Apple’s motion for JMOL with regard to damages while the motion in VirnetX, Inc. v. Cisco Systems, Inc., et al. related to Defendants’ motion to exclude the testimony of Plaintiff’s damages expert. In each, Plaintiff’s damages expert utilized the NBS to ultimately conclude a 45%-55% profit split with the majority going to the Defendant. Defendants in both matters argued that Plaintiff’s expert failed to explain why the parties would have agreed to this particular split of the profits. Judge Davis disagreed in both matters, finding that Plaintiff’s expert sufficiently accounted for and explained the profit split in his damages analyses.