After Lucent: how the federal circuit became more rigorous on damages

The United States Court of Appeals for the Federal Circuit has recently demonstrated a renewed scrutiny of damages awards, perhaps in response to the Supreme Court’s increasing scrutiny of patent issues, or the clamour for patent law reform, or perceptions of outlandish damages, say Kevin McCabe and Mark Fox Evens.

All parties to patent litigation will benefit from a deeper understanding of the Federal Circuit’s analytical framework for reviewing patent damages awards.

The patent damages statute, 35 USC 284, provides:

“Upon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court.”

Patent damages are typically classified as either lost profits or a reasonable royalty. The landmark decision in Georgia-Pacific Corp. v. U.S. Plywood Corp. established the framework for determining a reasonable royalty based on 15 factors that are presented by each party during trial, often through expert testimony. The Georgia-Pacific test creates the analytical framework for hypothetical negotiation between the parties.

By assuming the patent’s validity and by placing the negotiation at the time of infringement, the test seeks to recreate an arm’s-length negotiation before the lawsuit, when the parties would have negotiated willingly.

Three important decisions—Lucent Technologies, Inc. v. Gateway, Inc., i4i Ltd. v. Microsoft Corp. and ResQNet.com, Inc. v. Lansa, Inc.—demonstrate a shift in the Federal Circuit’s scrutiny of damages awards. These decisions provide significant lessons for both plaintiffs and defendants.

In Lucent, Microsoft appealed against a jury award of over $350 million to Lucent, which was worth approximately 8 percent of the price of Outlook, the Microsoft product that the jury found had infringed Lucent’s patent. The infringement involved the date-picker tool, a small aspect of Outlook. The Federal Circuit found that the damages calculation lacked sufficient evidentiary support and remanded the damages issue.

The Federal Circuit focused on four Georgia-Pacific factors: factor 2 (the rates paid by the licensee for the use of other patents comparable to the patent in suit); factor 10 (the nature of the patented invention); factor 11 (the extent to which the infringer has made use of the invention); and factor 13 (the portion of profit creditable to the invention). It also addressed the proper application of the entire market value (EMV) rule.

In discussing factor 2, the Federal Circuit held that eight licence agreements were not sufficiently comparable to the technology at issue and thus did not support the award. As to factors 10 and 13, the Federal Circuit found that the trial record established that Outlook’s infringing date-picker feature was not a substantial portion of Outlook’s value, but only a minor aspect of a much larger software program and that the profit creditable to the date-picker tool was very small.

In assessing factor 11, the Federal Circuit observed that the damages award needs to be correlated to the extent that the infringing method is used by consumers, finding that the plaintiff produced no evidence showing how often consumers used the date-picker tool. Even evidence of use after the hypothetical negotiation would have assisted the analysis, in the Federal Circuit’s view.

As for the EMV, the Federal Circuit further found two flaws in the jury’s application of the rule. First, there was no evidence that the patented method was the substantial basis for consumer demand as required by Rite Hite Corp. v. Kelley Co. Second, Lucent’s expert improperly inflated the royalty rate and used the price of the Outlook software as the royalty basis to bypass the district court’s evidentiary ruling that the expert could not base the royalty on the computer’s price.

Although the Federal Circuit indicated that there was nothing inherently wrong with using the EMV of the computer or the software program per se as the basis of the award, it found the royalty rate excessive, since the rate had been applied to the entire computer/software without any evidence showing that the EMV should apply to the accused Outlook program.

In i4i Limited, the Federal Circuit addressed Microsoft’s appeal against a $200 million damages award for infringement resulting from including a custom XML editor in certain versions of its Microsoft Word product. Microsoft challenged the testimony of i4i’s expert and the sufficiency of the evidence supporting the damages award.

“The days of cobbling together a series of agreements, related and unrelated to the patents at hand, to support a damages award, are over. The evidence must be scrubbed carefully to fit the appropriate Georgia- Pacific factor.”

Microsoft contended that the i4i expert’s ‘reasonable’ royalty of $98 per infringing act was exorbitant because certain Word products cost as little as $97 and it exceeded licensing amounts paid by Microsoft on other patents. The Federal Circuit found that the i4i expert’s assumptions were conservative and found that his calculations met the standards of relevance and reliability. To support its damages claim, i4i’s expert relied on Georgia-Pacific factors 3, 5, 6, 9 and 11, and explained how he positively and negatively adjusted his baseline royalty rate of $96 per act of infringement to the final royalty rate of $98. The jury seems to have relied on factors 6 and 11 most significantly in determining the damages award of $200 million.

In discussing factor 6, i4i relied on internal Microsoft statements that the custom XML editor was “one of the most important ways” of encouraging users to purchase new Word versions. To support factor 11, i4i introduced statements by Microsoft employees touting the significance of the infringing aspect, with specific language that the accused XML editor was not a “slight addition [but i]t’s more like 90 percent of the value”, was “where the future is, seriously” and was “the glue that holds the Office ecosystem together”.

Microsoft’s appeal against the damages award was complicated by its failure to file a post-trial motion on this issue, thus failing to preserve it. A post-trial motion would have changed the standard of review, allowing the court to review the sufficiency of the evidence under Lucent, as urged by Microsoft. Instead, the court could only review the issue under the much narrower, highly deferential standard applied to denials of new trials.

The Federal Circuit refused to overturn the award based on the sufficiency of the evidence, because it was not prepared to rule that the record contained no evidence to support the verdict or that this award was clearly excessive.

In ResQNet, Lansa cross-appealed a $506,305 judgment against it for past infringement of patents related to screen recognition and terminal emulation processes. ResQNet’s expert, in applying Georgia-Pacific factor 1, relied on a series of seven licence agreements as part of his analysis that the appropriate royalty rate was 12.5 percent.

The Federal Circuit faulted the ResQNet expert’s reliance on certain of those licence agreements in applying Georgia-Pacific factor 1, finding “particularly troubling” the reliance on five agreements that drove the double-digit royalty rate. The Federal Circuit explained that, under factor 1, the relevant inquiry is evidence of “the licensing of the patent in suit”, not the existence of other licence agreements.

Because five of the agreements had nothing to do with the claimed technology, they could not be relied on to arrive at a reasonable royalty. The Federal Circuit noted that the expert “misunderstood (or worse, misrepresented)” the five agreements in justifying his reliance on them. ResQNet’s expert failed in one of the principal tasks of an expert—to convey his opinion, not just in a convincing manner, but also in a credible manner.

These cases demonstrate that parties need to prepare their damages case carefully. The days of cobbling together a series of agreements, related and unrelated to the patents at hand, to support a damages award, are over. The evidence must be scrubbed carefully to fit the appropriate Georgia-Pacific factor. The expert’s report must be straightforward and it must be credible.

Motions in limine should be employed to keep out unsupported opinions, and counsel must preserve the record by proper objections and Rule 50 motions. To better understand the damages issues, trial counsel should include an Early Case Assessment, and damages should remain a focus throughout the preparation of the party’s case. These cases teach important lessons for all similar matters: