An often-important part of a reasonable royalty analysis in patent infringement litigation is determining whether or not there are comparable license agreements that would prove useful in a Georgia-Pacific1 or similar analysis. Even a carefully performed license agreement analysis that concludes there are no comparable agreements can be important by showing an expert’s due diligence.
Given some recent court decisions, one might reasonably question whether it is possible to rely on a comparable license analysis as part of a reasonable royalty determination that would survive appeal. Several Court of Appeals for the Federal Circuit (“Federal Circuit”) decisions reach seemingly inconsistent conclusions as to the reliability of using actual licenses for the subject patent(s) or licenses for other patents as a basis for determining a reasonable royalty.2 In ResQNet, the court fueled the debate as to which licenses can be considered in determining a reasonable royalty and what adjustments, if any, should be made to those transactions to achieve a reliable conclusion. Further, in Wordtech Systems, the Federal Circuit rejected licenses to the patents-in-suit entered into by the patentee-plaintiff because the royalty structure of most of those real-world licenses was based on a running royalty, whereas the patentee proposed a lump-sum royalty. The Court also rejected two real-world agreements that were based on a lump-sum payment structure because both were silent as to how the lump-sum payments were determined.3 The Federal Circuit has been clear that there must be a factual basis to associate the royalty rates used in prior licenses to the particular hypothetical negotiation at issue.4 What is less clear is exactly how the Court expects comparability of prior licenses to be evaluated in order to measure the reasonable royalty that would result from a hypothetical negotiation.
The Federal Circuit has commented on the parties’ insufficient analysis of the terms and conditions of actual licenses relative to the hypothetical license, and the lack of explanation as to how those differences would impact a reasonable royalty rate. As the Federal Circuit stated in Lucent Technologies, Inc. v. Gateway, Inc., a reasonable royalty “cannot stand solely on evidence which amounts to little more than 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….”5 It appears from an interview with Federal Circuit Chief Judge Rader that he encourages the use of comparable license agreements, but only if the use of those agreements is accompanied by appropriate analyses of the differences between those agreements and the hypothetical license, including any adjustments to the comparable license royalties that should be made to arrive at a reasonable royalty.6
In order to discuss what constitutes a comparable license in patent litigation, one should look at both the technical comparability and economic comparability of the subject real-world agreement. It has been our experience that terms of many potentially comparable real-world license agreements are so substantially different from the hypothetical license as to preclude their use for comparative purposes. Such licenses would include agreements where the licensed technology is substantially different than the subject patented technology and agreements where the financial terms cannot be isolated to the relevant technology—as may be the case with many cross-licensing agreements or extremely broad grants of technology and know-how, which may be far beyond the scope of the patent-at-issue.
From a technical perspective, the damages expert needs to understand how the subject matter (product, industry/application, patent claims, etc.) of the real-world license relates to that of the hypothetical negotiation. Furthermore, the expert should also look at the nature of the granted rights in the subject real-world agreement. How many patents are included? Is there other IP, such as trademarks or know-how, included? Do other terms and conditions exist that may differ from the hypothetical license– cross licensing, supply agreement terms, field of use, or geographic restrictions? In matters involving claims for only patent infringement, a reasonable royalty analysis is typically based on the value of the stand-alone patent(s)-in-suit. The alleged infringer receives no additional know-how, IP rights, or technical support from the patent holder.
To be comparable, the subject matter of the license should be the same or similar to that of the hypothetical license. Ideally, the license will include the patent(s)-in-suit. If a license containing the patent(s)-in-suit does not exist, then the expert can look for licenses involving similar technology.7 How can the damages expert evaluate the subject matter comparability of a real-world license? Perhaps collaboration with a technical expert would be helpful to the damages expert. The damages expert could also examine whether the real-world license includes rights to patents cited as prior art in the patent(s)-in-suit or rights to other patents used in accused products. The expert may also review whether the patents included in a real-world license are classified under the same Cooperative Patent Classification (“CPC”) or U.S. Patent Classification (“USPC”) codes as the patent(s)-at-issue. Ultimately, the expert needs to reach a conclusion as to whether the real-world license involves patented technology used in similar applications and industries as the hypothetical license. To use an imperfect, but useful, real estate analogy, you want to be looking for the same type of house in the same neighborhood as the property being valued. The further you deviate from the type of house and the neighborhood, the less relevant is your comparison.
From an economic perspective, the damages expert needs to understand how various terms and conditions of the real-world license (payment structure, exclusivity, etc.) affect the pricing of that agreement relative to the hypothetical license. Following are discussions of how certain of those terms may impact the use of a real-world license as a comparable agreement.
In both the real world and the hypothetical “but-for” world of damages, payment terms of licenses reflect the value of the licensed subject matter. In the real world, the payment terms are known. In the hypothetical “but-for” world, the payment terms are initially unknown. It is the role of the damages expert to ultimately opine on the royalty rate, royalty base, and payment terms of the hypothetical license agreement. Support for the payment structure (such as a running royalty, up-front payments, paid-up license, milestones or tiered royalties, and cap on payments) can be based on the experience of the parties, unique economic considerations, or third-party comparable licenses. Even if real-world license agreements do not directly determine the actual percentage royalty rate, they may still be useful and relevant in determining the payment structure of the royalty, as some industries generally license under a common payment structure.8
Georgia-Pacific Factor 3 addresses “[t]he nature and scope of the [hypothetical licenses] license, as exclusive or non-exclusive; or as restricted in terms of territory or with respect to whom the manufactured product may be sold.”9 While exclusivity and geographic scope of a license would impact a royalty rate, damage experts often agree that the hypothetical license would be non-exclusive and would be for U.S. rights,10 without geographic or customer-related restrictions within the U.S.11 All else being equal, an exclusive license tends to command a higher royalty rate than a non-exclusive license.12
Georgia-Pacific Factor 5, which considers the commercial relationship between the licensor and licensee,13 can be relevant in determining the comparability of licenses. Real-world license agreements may involve non-competitive or competitive parties. The relative bargaining strength of the parties is very much a part of the real-world licensing agreement, but can be a debatable issue between damage experts as to where the bargaining advantages lie and the importance of bargaining strength in the hypothetical negotiation. All else being equal, one would expect a license between competitors to command a higher royalty rate than a license between non-competing parties.
However, other conditions may also be economically relevant to analysis of Georgia-Pacific Factor 5. Does the real-world license agreement represent an intercompany transfer between related parties? If so, it may be important to identify whether such agreement reflects an arm’s-length pricing standard. Another factor that could have a profound impact on a reasonable royalty is whether either the patent(s)-in-suit or the real-world licensed patent(s) is part of an industry standard (standard essential patent, or “SEP”) and whether the patent owner has agreed to license the patented technology on a reasonable and non-discriminatory (“RAND”) basis. If the hypothetically licensed patent is SEP and to be licensed under RAND terms, then patents not licensed under RAND terms would generally make for poor comparables. Even patents licensed under RAND terms still have to be carefully evaluated for comparability.
Other economic factors, such as market conditions, competitive technologies, age of technology and technological obsolescence, timing of the agreements, and barriers to entry, can all impact comparability. Generally speaking, all else being equal, broader grants of economically valuable subject matter or grants of rights in more economically lucrative markets may command higher royalty rates than licenses of lesser rights or rights in less lucrative markets. Conversely, all else being equal, one would expect that the hypothetical license for a stand-alone patent(s) would command a lower royalty relative to a real-world license agreement that licensed a broader range of subject matter.14 Importantly, this assumes that the additional subject matter is of sufficient value to impact the royalty rate.
Certain legal and market-related considerations can introduce additional challenges to comparability because they may not necessary translate directly into license terms, but rather relate to the general conditions surrounding the license. For example, in order to determine a reasonable royalty, the damage expert as a matter of law assumes that the patent(s)-in-suit is both valid and infringed. This is typically not the assumption of the licensee in a real-world patent license negotiation prior to the adjudication of a patent. All else being equal, the elimination of the risk of invalidity or of non-infringement in the hypothetical negotiation would suggest a higher royalty rate than if those risks did exist, as is the case in many real-world licenses. Certain other license agreements may lack some degree of comparability because they are settlement agreements resulting from actual or threatened litigation. This fact could also impact comparability, as settlement agreements often reflect unique market-driven, economic, and other factors.
Finally, once differences in rights or economics are identified between the potentially comparable real-world license and the hypothetical license, it may be possible to make adjustments to the real-world royalties for use in the hypothetical negotiation. With sufficient information, it may be possible to conduct apportionment analyses or to make adjustments to account for differences in market size, stage of development, other IP rights, competitive situation, exclusivity, and so on. Such adjustment analyses are highly case-specific.
A comparability analysis should take into account the key licensing terms and economic conditions surrounding the hypothetical negotiation so that these factors can be compared (or contrasted) with those of potentially comparable real-world agreements. These factors need to be considered in their entirety but may also be analyzed individually. For instance, an attempt should be made to isolate any significant differences in key terms and licensing conditions so that the actual license value can be apportioned between the technology of the patent(s)-in-suit and other licensed subject matter not included in the hypothetical license. In some cases, the technical or economic dissimilarity between real-world licenses and the hypothetical negotiation may be too great to overcome, rendering the real-world licenses not comparable. In other cases, the technical or economic differences may require some adjustment to the real-world licenses for use as comparable agreements, or may provide directional guidance as to whether one would expect a reasonable royalty to be higher or lower than that defined in the real-world licenses. As mentioned previously, the greater the dissimilarity between key licensing terms and other licensing conditions, the more difficult it becomes to extract useful information from the real-world licenses for use in determining a reasonable royalty. As many court decisions have shown, the damage expert is at some peril when using real-world patent license agreements as comparables to the hypothetical license. However, this risk can be somewhat mitigated through careful analysis and explanation of the relevancy of the comparable and potentially comparable licenses.
Kristopher A. Boushie