The Ripple Effect of Rising Interest Rates on Patent Litigation
The Ripple Effect of Rising Interest Rates on Patent Litigation
Over the last decade, interest rates have been well below historic long-term averages and have risen rapidly over the last 12 months. In the low interest rate environment of the last decade, the calculation of prejudgment interest had largely become an afterthought when assessing the risks and rewards of potential patent damages awards. This is about to change. Further, the boon to patent litigation in general, spurred in part by a decade of low interest rates, may be put at risk as interest rates move upwards and remain elevated.
The Federal Reserve’s focus for the foreseeable future will be on engineering a “soft landing” for the U.S. economy – and, understandably, not on the prospects of patent litigators or their clients. Therefore, it is incumbent on patent litigators to understand how a prolonged period of high interest rates and inflation could have unintended impacts on patent damage calculations and patent litigation in coming years.
Impacts of Rising Interest Rates on Prejudgment Interest Calculations
When a party to a case is awarded damages, it may also be entitled to prejudgment interest on the amount of that judgment. Prejudgment interest is additional money that a court can award based on the interest that the judgment would have earned over the period from the date the damages are entitled to the receiving party to the point in time when it actually receives the payment. For patent infringement litigation, that time period can be many years, and as such, the combined effects of compounding over longer periods at higher interest rates can substantially increase the amount ultimately owed to the prevailing party.
As shown in the chart below, prejudgment interest on a $10 million award under a 2% interest rate compounded over 10 years would result in an additional $2.2 million in prejudgment interest – a 20% increase in damages. However, at an interest rate of 7%, the paying party would owe an additional $9.7 million, almost doubling the total amount owed from the $10 million in damages to $19.7 million in damages plus prejudgment interest.
Hypothetical Prejudgment Interest at 2% and 7% Interest Rates on $10 Million Compounded for 10 Years
As the above shows, in this higher interest rate environment, would-be infringers should take extra care to account for the additional risk of the effects that higher interest rates will have on prejudgment interest calculations down the road. Patent holders would also do well to consider the rise in interest rates during venue selection, as statutory rates for prejudgment interest calculations in certain jurisdictions are pegged to the prime rate – which, as discussed, is rapidly increasing.
In patent infringement cases where the court and the finder of fact agree that a lump-sum royalty (as opposed to a running royalty) is applicable, the risk of substantially increased prejudgment interest awards due to higher interest rates is particularly acute. This is because even if interest rates stop rising and begin to decline over the next few years, under a lump-sum structure, the highest interest rates in earlier periods apply to the full amount of the damages awards and those higher (and ostensibly, unpaid) interest payments are then compounded over the whole period (in jurisdictions that allow for compounding in prejudgment interest calculations). This is not the case under a running royalty structure where the highest rates only apply to the fraction of the award corresponding to the higher interest rate period. In fact, in a sample calculation performed for this article, the prejudgment interest on a lump-sum royalty was more than two times that of the running royalty when assuming the damages awards, applicable interest rates, and time periods were all the same.
Impacts of Rising Interest Rates on the Panduit and Georgia-Pacific Factors
Higher and rising interest rates over the next few years may also have implications for certain Panduit and Georgia-Pacific factors.
Under Panduit factor two and certain Georgia-Pacific factors, damages experts consider the costs to develop (1) the patented technology, (2) non-infringing alternatives (“NIAs”), and (3) design-arounds. Of particular importance to these cost analyses are the research and development (“R&D”) costs associated with claimed NIAs or design-arounds. As interest rates rise, the borrowing costs to fund R&D rises, and as inflation rises, the cost of R&D inputs rise; as such, patent holders may be better positioned to argue that any claimed NIAs or design-arounds would have been cost prohibitive.
Under Panduit factor four and certain Georgia-Pacific factors, damages experts analyze the income stream associated with the patented technology. In a higher interest rate environment and a higher inflationary environment, many companies will be faced with higher costs of goods sold, operating costs, and borrowing costs. To the extent these companies cannot pass these additional costs to consumers in the form of higher prices, the amount of profit derived from products incorporating the patented technology will in all likelihood be relatively lower. This can reduce the amount of income associated with the patented product which by extension reduces the potential damages.
Would-be licensors and licensees should take extra care now when negotiating patent license agreements because any reduced emphasis on costs and profits for determining damages could lead parties and damages experts to place greater emphasis on the market approach (i.e., comparable transactions analysis).
Impacts of Rising Interest Rates on Patent Litigation
Rising interest rates may have negative impacts on patent litigation in coming years.
In the near term, rising interest rates may reduce capital flows to patent litigation funders because investors can find adequate returns under more traditional investments, like fixed income, which are now offering rates of return that have not been available in more than a decade.
Further, all else equal, higher interest rates could reduce the amount of discretionary spending on activities such as R&D because more cash is needed for debt service. With high rates of inflation, reduced R&D budgets do not go as far because companies must pay more for inputs, further reducing the number of patented technologies developed. Given that around two-thirds of patents result from commercial R&D efforts, the combination of rising interest rates and inflation may reduce the number of patents, and by extension reduce the number of patent disputes.
While it is not clear how long the Federal Reserve will keep interest rates elevated, what is clear is that interest rates can no longer be an afterthought for patent litigators.
Authors: Bill Miras and Ava Giannella