March 01, 2012

It is not uncommon in patent infringement cases for a reasonable royalty to be based on the sale of an infringing product (whether that product infringes at least one claim of an asserted product patent or is manufactured using a process that infringes at least one claim of an asserted method patent). However, what is the appropriate royalty base when, rather than selling the accused product, the accused infringer merely uses the accused product? In Michael S. Powell v. The Home Depot U.S.A., Inc. (“Powell v. Home Depot”) the United States Court of Appeals for the Federal Circuit (“the Court”) provides insight on the determination of such “use-based” reasonable royalties.

Background

Home Depot generates substantial revenue and profit from the sale of lumber. Often times, that lumber is cut to particular lengths desired by individual customers. Home Depot’s stores are outfitted with radial arm saws, which Home Depot employees operate to provide custom-cut lumber.

In 2002 and 2003, Home Depot noticed that employees were suffering injuries including lacerations and finger amputations from accidents while cutting lumber for customers with the radial arm saws. Home Depot considered removing the saws but ultimately determined that the benefits derived from providing custom-cut lumber outweighed the risks and chose to search for another solution to their employee injury problem. Home Depot turned to Michael Powell, Home Depot’s point of contact for the installation and repair of radial arms saws, to find a solution.

Mr. Powell developed a safety guard for the radial arm saws and in July 2004 presented a prototype to Home Depot. By August 2004, Home Depot ordered and installed eight more units for testing in its stores. Home Depot paid Mr. Powell $2,000 each for the units. That same month, Mr. Powell filed an application for a patent on his saw guard.

Unbeknownst to Mr. Powell, Home Depot invited representatives from Industriaplex Inc. (“Industriaplex”) to view Mr. Powell’s invention and challenged them to provide nearly identical guards at a price less than $2,000 each. Industriaplex met Home Depot’s challenge and ultimately sold Home Depot nearly 2,000 saw guards at price of approximately $1,295 each. During that time, Mr. Powell continued to discuss supplying Home Depot with additional saw guards but the parties never entered into a subsequent purchase agreement after the initial eight prototypes.

Mr. Powell’s patent, U.S. Patent No. 7,044,039 (“the ‘039 patent”), had been issued on May 16, 2006. Mr. Powell subsequently sued Home Depot for patent infringement.

Following a 14 day trial, the jury found that Home Depot willfully and literally infringed the ‘039 patent. The jury was then instructed to determine what amount “would [Mr. Powell] have received from [Home Depot] for the right to use his patented invention in the United States.”1 The jury subsequently awarded Mr. Powell damages totaling $15 million, which equated to approximately $7,736 per infringing unit. Additionally, the district court awarded $3 million in enhanced damages as well as $2.8 million in attorneys’ fees. Including prejudgment interest, the judgment totaled nearly $24 million.

Home Depot challenged various issues on appeal, including specific arguments related to damages. Two damages-related issues were addressed by the Court in their order. First, the Court addressed Home Depot’s claim that a reasonable royalty cannot exceed lost profits. Second, the Court addressed whether the jury’s award was supported by substantial evidence.

Lost Profits – A Cap on Reasonable Royalty Damages?

In its appeal, Home Depot argued that a reasonable royalty cannot exceed lost profits. This issue has been previously addressed in State Industries Inc. v. Mor-Flo Industries, Inc.2 and again in Golight, Inc. v. Wal-Mart Stores, Inc.3 where the Court found, “[t]here is no rule that a royalty be no higher than the infringer’s net profit margin.”

However, Home Depot argued that the upper bound to the reasonable royalty should be reflected not by its net profit margin (the infringer’s profit) but rather by the profits Mr. Powell expected to earn (the patentee’s profit) from selling his saw guards to Home Depot. Home Depot pointed to evidence presented to the jury indicating that in 2004 Home Depot and Mr. Powell had negotiated a price for Mr. Powell’s saw guards (apparently no sales were ever made at that price). Based on this price, evidence was presented to the jury that a conservative estimate of Mr. Powell’s profit from building and installing the saw guards was $2,180 per unit. As such, Home Depot argued that $2,180 per unit represented an upper bound on damages rendering the jury’s award of $7,736 per unit unreasonable.

The Court disagreed with Home Depot and cited two reasons.

First, understanding it is settled law that an infringer’s net profit margin does not constitute a ceiling on damages, the Court found that it is equally inappropriate to impose a ceiling on damages based on the patentee’s profit expectation. In support of its finding, the Court cited Stickle v. Heublein, Inc., in which the Court rejected the accused infringer’s position that the sales price of the patented product capped the reasonable royalty.4 Furthermore, the Court reasoned that “[w]hile either the infringer’s or the patentee’s profit expectation may be considered in the overall reasonable royalty analysis, neither is an absolute limit to the amount of the reasonable royalty that may be awarded upon a reasoned hypothetical negotiation analysis under the Georgia-Pacific factors.”5

Second, the Court found that while a price resulting in a $2,180 profit margin may have been agreed to in 2004, prior to the issuance of the patent, a different price (and resulting profit margin) may have resulted from a negotiation in May 2006 when the patent issued and infringement began. Per Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., “[t]he key element in setting a reasonable royalty after determination of validity and infringement is the necessity for return to the date when the infringement began.”6 The Court reasoned that by May 2006, Home Depot and Mr. Powell would have benefited from two additional years after their initial negotiation during which they would have observed the effectiveness of Mr. Powell’s invention as embodied in the saw guards provided to Home Depot by Industriaplex. As such, the Court was not convinced that Mr. Powell’s $2,180 per unit profit expectation from 2004 was a reliable approximation of the maximum reasonable royalty the parties would have agreed to during the May 2006 hypothetical negotiation.

Damages Award – Supported by Substantial Evidence?

The second damages-related issue addressed by the Court was whether the jury’s damages award was supported by substantial evidence. Home Depot argued that evidence presented to the jury did not support an award of $7,736 per unit.

Both parties presented multiple damages theories for the jury to consider. One of Home Depot’s theories was based on the $2,180 per unit profit margin that Mr. Powell would have received as a result of the 2004 agreement with Home Depot. Other theories offered by Home Depot involved royalty rates ranging from 3% to 50% applied to the $1,295 per unit price that Home Depot paid Industriaplex for their saw guards based on Mr. Powell’s design.

The damages theories proffered by Mr. Powell’s damages expert included royalty rates ranging from $2,180 per unit (as reflected in the 2004 agreement) up to approximately $8,500 per unit, which represented the amount Home Depot paid to replace radial arm saws in 71 stores so that the saws would be compatible with Industriaplex’s saw guard. Mr. Powell’s damages expert also testified as to why the parties would have negotiated a royalty greater than Mr. Powell’s lost profits and why lump sum rather than a running royalty was appropriate. Additionally, evidence was presented indicating: 1) injury claims before the saw guards were installed were costing Home Depot in excess of $1 million per year; 2) Home Depot’s CEO, Robert Nardelli, indicated to his staff that employee injuries were not acceptable and that saws must be fixed or removed; and 3) not a single injury was reported in Home Depot stores where the Industriaplex saw guard was installed, whereas other stores continued to report radial arm saw-related injuries. However, upon cross examination, Mr. Powell’s damages expert also conceded that a reasonable royalty would be some amount less than $7,000 per unit.

Considering the testimony and evidence provided to the jury, the Court was not convinced that the jury’s award was “so outrageously high…as to be unsupportable as an estimation of a reasonable royalty.”7 Specifically, the Court pointed to the $8,500 per unit that Home Depot spent in 71 stores to replace saws that were incompatible with the Industriaplex guards. The Court considered the $8,500 to reflect “evidence of [the] cost savings that Home Depot could expect to achieve by reducing claims from employee accidents while using the radial arm saws.”8

Evidence of the cost savings and Home Depot’s desire to keep the radial arm saws in light of the advantages it derived from offering custom cut lumber reflect the benefits Home Depot stood to derive from using the patented technology. The Court held that the jury’s consideration of this evidence was proper and found “that when considering the amount of a use-based reasonable royalty…a jury may consider not only the benefit to the patentee in licensing the technology, but also the value of the benefit conferred to the infringer by use of the patented technology.”9 The Court supported its finding by referencing its 2007 opinion in Monsanto v. McFarling. In that case, the Court found that in “determining the amount of a reasonable royalty, it was proper for the jury to consider not only the benefit of the licensing program to [the patentee], but also the benefits that [the patentee’s] technology conferred on [infringers].”10

Additionally, the Court was not persuaded by Home Depot’s argument that the jury’s award was unreasonable given the testimony under cross examination of Mr. Powell’s damages expert (referring to his testimony in which he conceded that a reasonable royalty would be some amount less than $7,000 per unit). Rather, the Court found the award to be “within the range encompassed by the record as a whole.”11

Conclusions

From their opinion in Powell v. Home Depot, the Court reaffirmed that in determining a use-based reasonable royalty it is appropriate to consider the value of the benefit conferred to the infringer by using the patented technology. More generally, the Court indicated that while it may be instructive to consider the infringer’s and/or patentee’s profits in determining a reasonable royalty, neither is necessarily an absolute limit on reasonable royalty damages. Finally, the Court reiterated the necessity of utilizing the hypothetical negotiation construct to determine the reasonable royalty and particularly underscored the importance of considering the appropriate timing of the hypothetical negotiation.

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1 Powell v. Home Depot U.S.A., Inc., 663 F.3d 1221, 1237 (Fed. Cir. 2011).
2 State Industries, Inc. v. Mor-Flo Industries, Inc., 883 F. 2d 1573, 1580 (Fed. Cir. 1989).
3 Golight, Inc. v. Wal-Mart Stores, Inc., 355 F. 3d 1327, 1338 (Fed. Cir. 2004).
4 Stickle v. Heublein, Inc., 716 F.2d 1550, 1563 (Fed. Cir. 1983).
5 Powell v. Home Depot U.S.A., Inc., 663 F.3d 1221, 1238-9 (Fed. Cir. 2011).
6 Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152, 1158 (6th Cir. 1978) (Markey J. sitting by designation).
7 Citing Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538 at 1554 (Fed. Cir. 1995).
8 Powell v. Home Depot U.S.A., Inc., 663 F.3d 1221, 1240 (Fed. Cir. 2011).
9 Powell v. Home Depot U.S.A., Inc., 663 F.3d 1221, 1240 (Fed. Cir. 2011).
10 Monsanto v. McFarling, 488 F.3d 973, 980 (Fed. Cir. 2007).
11 Citing Unisplay, S.A. v. Am. Elec. Sign Co., 69 F.3d 512, 519 (Fed. Cir. 1995).