"Reasonable Royalty Payments" In Need Of A Reform

The contentious issue addressed in the recent Intellectual Property Colloquium, hosted by Professor Doug Lichtman of the UCLA School of Law, was the way the courts calculate patent damages. As the debate over the U.S. patent reform continues, Professor Lichtman has made available a series of excerpts from the Senate and the Federal Trade Commission to enable the listeners to identify the nature of the problem and the array of possible solutions to explore.

Typically in a patent infringement case, the two main types of remedies include compensation for ‘lost profits’ or court determined reasonable royalty. In addition, if the infringement is found to be wilful, the damages are tripled. An injunction is another option. The concern, however, is whether the juries who are awarding excessive damages are encouraging unnecessary litigation and taxing legitimate businesses and research activities.

Under the option of claiming the ‘lost profits,’ the test requires a patentee to demonstrate infringement causing the patentee to lose profits, kind of like a ‘but for’ test. The limitation inherent to compensation for ‘lost profits’ is the need to demonstrate the lost profits with certainty. In addition to the difficulty in proving the sales and profits, a serious problem arises when a company, instead of dealing in products, is a patent licensing entity or the one that deals in convoyed goods.

The other option then is reasonable royalties. A reasonable royalty is generally deemed to be the amount that a licensee would be willing to pay through typical negotiations between a licensor and a licensee. However, the court assumes that both parties agree that the patent is valid and that there is an established infringement. As a matter of well established law, the U.S. court, in Georgia-Pacific Corp. v. United States Plywood Corp., 318 FSupp 1116, 6 USPQ 235 (SD NY 1970), has delineated 15 factors using which a jury can determine the type of monetary payments that would compensate for a patent infringement. Some of these overarching criteria include: the nature and scope of the license- exclusive or non-exclusive, restricted or non-restricted; the established profitability of the patented product, its commercial success and its current popularity; the extent to which the infringer used the invention and any evidence probative of the value of that use, etc.

It appears that the two big concerns regarding royalty damages are: 1) unpredictability, and 2) the focus on the value of the entire infringing product as opposed to the actual patent contribution itself. The unpredictability stems from the fact that 15 is just too big a number for the jury to consider while deciding on the monetary value of the damages. Furthermore, there is no guidance on the application of these criteria and so the jury decision ends up being pretty arbitrary. The commentators recommend that common law should reform the test to provide a shorter list of Georgia-Pacific factors, and the juries should be given better guidance. Also, judges should act as gate keepers to ensure that the test is correctly applied.

With regards to the second issue, both Steve Appleton, CEO of Micron Technology, and Dave Kappos, Chief-IP lawyer of IBM, emphasize the need to have an appropriate standard for reasonable royalty damages in order for modern businesses to operate effectively and to save the precious time of skilled engineers in being innovative than in fighting litigation. They both point to the fact that the face of innovation has changed and most of the consumer products are complex and incorporate thousands of patented inventions in one package. Additionally, many new innovations require investments of unprecedented size to achieve a single new product protected by a single patent. This multiple source input has been facilitated by: 1) open innovation environments; 2) technology standards, where innovators work collaboratively to create a common platform for product-level competition; and 3) licensing and cross-licensing of technology to gain access to other’s innovations.

Many commentators state that in order to remain competitive, the patent system must accommodate all these innovations models. The problem today is that traditionally the patent law provides that the core purpose of reasonable royalty damages is to compensate the patentee by awarding as damages a royalty fee approximating the true market value of a license to practise the patented invention. What is remarkable is that the law today permits reasonable royalty rewards that exceed the infringer’s entire profit on the infringing product or service, indicating that the entire standard has no basis in today’s economic reality.

The scope of the problem is further clarified by this example by Philip S. Johnson, the chief IP Counsel for Johnson & Johnson. He proposes that “if the reasonable royalty for using a patented, variable-speed automobile windshield wiper is one dollar, it should not matter whether the amount is assessed as one dollar per wiper assembly, or one dollar per car.” This implies that if the patent claim is drafted as “an improved car with the [novel] windshield wiper assembly,” the reward should not be more than had the claim been
“an improved [novel] windshield assembly.” Since there is no variation in the resulting incremental value to an auto manufacturer of using the invention, there should not be any variation in the reasonable royalty damages awarded.

In his testimony, Dave Kappos suggests many solutions to an effective royalty damage calculation. One of the significant suggestions is that “if a patentee sells a product that includes all the essential features of a patented invention, then the patent rights are exhausted. This means that the patent can no longer be asserted against downstream buyers of that product. The theory is that in such a transaction, the patentee has bargained for and has received a full compensation when the product was sold, and is not entitled to collect an additional royalty.” The idea is to move the focus on the “essential features” to result in fair compensation for the patentee. This way the patentee is neither overcompensated, by including the value contributed by others, nor is the patentee under-compensated, by excluding the value provided by the patented inventions.

Another proposal, as forwarded by Taraneh Maghame, the Vice President of Tessera Inc., is termed the “apportionment proposal.” This test “assesses damages according to the patent’s incremental benefit to the patent user, as measured by the invention’s ‘specific contribution over the prior art.'” Consequently, the reasonable royalty damages will not overcompensate the patent holder.

In conclusion, the reasonable royalty damages calculation is an essential part of the IP reform and is currently in a vulnerable state making it easy to exploit. The excerpts from some of the leaders of the U.S. IP reform indicates that the problem is pressing and solutions are available. Since a typical infringement case almost always puts a 100% focus on either proving or disproving the patent validity and infringement, it is commendable that this issue of damages has been surfaced and has attracted extensive discussions and hearings. As planned, this IP reform should be able to encourage scientists and engineers to focus on the innovation side of the things, while minimizing their concerns of defending an impending lawsuit, thereby improving investments, efficiency and fairness.