Reasonable Royalties and Lost Profits Damages Help “Cure” Infringement

Patent infringement litigation is becoming increasingly common. When it comes to damages, reasonable royalties represent the statutory minimum, but plaintiffs often are able to recover greater amounts in the form of lost profits. How these damages are determined depends on a variety of factors.

Intellectual property is playing a critical role in today’s technology-driven world. And as IP owners aggressively protect their rights, patent infringement litigation is becoming increasingly common.

U.S. patent law authorizes a court to award damages “adequate to compensate for the infringement but in no event less than a reasonable royalty” for the infringer’s use of the invention. Reasonable royalties represent the statutory minimum, but plaintiffs often are able to recover greater amounts in the form of lost profits. How both are determined depends on a variety of factors.

Computing reasonable royalties
A reasonable royalty generally is defined as the amount that a hypothetical willing buyer and willing seller would agree upon as an appropriate payment for the use of the patent. Some courts may be willing to award royalties at a higher rate to serve as a deterrent to infringement. The rationale is that, if plaintiffs aren’t entitled to something beyond a reasonable royalty, infringement becomes a vehicle that allows competitors to effectively extract court-imposed licenses from patent owners.

Courts normally apply the 15 “Georgia-Pacific” factors to determine a reasonable royalty:

  1. Established royalties — that is, actual royalties received by the patent holder for licensing the patent at issue.
  2. Rates paid by licensees of comparable patents.
  3. Nature and scope of the license (exclusive vs. nonexclusive, field or industry of use, geographic restrictions).
  4. Patent holder’s licensing policies (no licensing, restricted licenses only).
  5. Commercial relationship between the patent holder and the licensee (competitors, joint venturers, inventor and promoter).
  6. Effect of the infringement on sales of the licensee’s other products.
  7. Duration of the patent and term of the license.
  8. Established profitability, commercial success and current popularity of products made under the patent.
  9. Utility and advantages of patented products over old modes or devices used for similar purposes.
  10. Nature of the patented invention, character of its commercial form as produced by the licensee and benefits to users of the invention.
  11. Extent of use of the invention by the licensee and value of that use.
  12. Portion of the profit that may be customary in the industry to allow for the use of the invention or similar inventions.
  13. Portion of the profit attributable to the use of the invention vs. nonpatented elements added by the infringer.
  14. Opinion testimony of qualified experts.
  15. Amount that a reasonable licensor and licensee would have agreed upon for the license, immediately prior to the infringement.

Not all of the factors are relevant in every case, but in determining reasonable royalty damages experts consider whether each factor is relevant, and, if so, its impact.

Recovering lost profits
Plaintiffs rarely settle for reasonable royalties, instead seeking lost profits whenever possible. The Sixth Circuit established the benchmark for lost profits damages in Panduit Corp. v. Stahlin Bros., outlining four components a plaintiff must establish to recover damages: 1) demand for the patented product; 2) an absence of acceptable noninfringing substitutes; 3) the patent holder’s manufacturing and marketing capacity to exploit the demand; and 4) the amount of profits the patent holder would have earned but for the infringement. Other courts have held that there’s no one “right” method for computing lost profits, but the Panduit criteria represent the most common approach.

Some of the Panduit components have evolved over time, though, including requiring an absence of acceptable noninfringing substitutes. Since its decision in State Industries, Inc. v. Mor-Flo Industries, Inc., the Federal Circuit has allowed plaintiffs to recover lost profits based on market share if acceptable substitutes are available. The infringer’s sales are allocated to the other sellers in the market on a pro-rata basis, thereby accounting for the effect legal competition would have had on the plaintiff’s profits.

Similarly, several courts have clarified the phrase “manufacturing and marketing capacity.” These courts consider whether a defendant’s manufacturing and marketing capacities are stronger than the plaintiff’s, examining factors such as production facilities, marketing expertise and budgets, distribution channels and brand loyalty.

If a plaintiff succeeds in satisfying Panduit, it must put forth a unit price. The unit price could be the price the plaintiff charges on its sales or the price the defendant charged, assuming their products were sufficiently comparable. Of course, the competition created by the infringement may have pushed down the price for both parties.

Framing a damages strategy
As businesses increasingly rely on patented intellectual property, more attorneys will find themselves facing the decision between reasonable royalties and lost profits. A damages expert can help you determine the best strategy for pursuing patent damages and structure the necessary discovery requests.

Sidebar: Beyond royalties and profits
In some cases, plaintiffs can recover damages in addition to reasonable royalties or lost profits. Theories include:

Price erosion. Price erosion is based on the infringer’s presence in the marketplace. But for that presence, the argument goes, the plaintiff could have sold its product at a higher price. Proving price erosion requires a comprehensive market analysis of competitive factors, such as market shares, price elasticity and the plaintiff’s cost structures. An expert also will adjust for the laws of supply and demand to formulate the state of the market in the absence of the defendant.

Lost collateral sales. A plaintiff may seek damages for diminished sales of items related to the patented product. The manufacturer of a patented razor, for example, may also suffer losses in sales of unpatented razor blades. To recover under this theory, the plaintiff must show that a product’s patent-related features drive customer demand and that the patented and unpatented components combine to form a functional unit.

Accelerated market entry. In cases where a patent was nearing its expiration date at the time of the infringement, a plaintiff might assert that the defendant enjoyed accelerated market entry. By earning a place in the market earlier than legally allowed, the defendant causes the plaintiff to lose sales and profits even after patent protection has lapsed.

Enhanced damages. Patent law allows for treble damages for willful infringement. An award of enhanced damages lies in the court’s discretion but must be commensurate with the level of culpability. The court will weigh factors such as whether the infringement was deliberate, whether any attempts were made to conceal infringement, the defendant’s remedial actions, and the defendant’s size and financial condition.