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July 8, 2005

Hypothetical Projections

Honeywell sued Hamilton Sunstrand Corp. (“HSC”) for patent infringement. Never mind the technicalities; the juicy fruit relates to infringement damage calculation, specifically "...the question presented to the court is whether sales projections that were unavailable at the time infringement began may be used as a royalty base to calculate damages." (District of Delaware July 5, 2005 decision in case 03-1153)

Upon a finding of infringement, the plaintiff is entitled to “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.” 35 U.S.C. § 284 (2001). “A reasonable royalty calculation envisions and ascertains the results of a hypothetical negotiation between the patentee and the infringer at a time before the infringing activity began.” Integra v. Lifesciences I, Ltd. v. Merck KGaA, 331 F.3d 860, 869 (Fed. Cir. 2003). Therefore, “[t]he first step in a reasonable royalty calculation is to ascertain the date on which the hypothetical negotiation in advance of infringement would have occurred.” Id. at 870. It is important to note, however, that the ascertainment of this date does not rigidly foreclose the factfinder from considering subsequent events. To enforce such rigidity would be to ignore a limitation inherent to the hypothetical negotiation method. “In a normal negotiation, the potential licensee has three basic choices: forego all use of the invention; pay an agreed royalty; infringe the patent and risk litigation.” Fromson, 853 F.2d at 1576. In a hypothetical negotiation, however, the factfinder “presumes that the licensee has made the second choice, when in fact it made the third.” Id. The unwanted effect is that the factfinder may be tempted “to pretend that the infringement never happened.” TWM Mfg. Co. v. Dura Corp., 789 F.2d 895, 900 (Fed. Cir. 1986). Thus, the hypothetical negotiation approach “must be flexibly applied as a device in the aid of justice.” Id.

Justice Cardozo’s opinion for the Supreme Court in Sinclair Refining lends further insight on the importance of maintaining a flexible approach to the hypothetical negotiation. In that case, the plaintiff loaned to the defendant “an experimental still for cracking petroleum oils to produce gasoline.” 289 U.S. at 690. As part of the consideration for the loan, the defendant agreed to assign any improvements it made on the still to the plaintiff. Id. Subsequently, the defendant successfully applied for a patent to which the plaintiff later claimed an interest pursuant to the loan agreement. Id. at 690-91. The defendant refused to assign the patent to the plaintiff, effectively forcing the plaintiff to sue the defendant for damages under a breach of contract theory. Id. at 691. During discovery, the plaintiff was denied information “as to the number of crackling stills constructed by the defendant under [its] patent, as to the extent and time of operation, and as to the amount of gasoline and other petroleum products yielded thereby.” Id. The district court sided with the defendant in part because “the value of the patent[] has no relation to the sales of the patented device, and that evidence of such sales would be inadmissible if offered.” Id. at 691-92. In other words, the district court held that since damages for breach are assessed as of the time of the breach, the value of the patent at that time was unrelated to any greater value it later obtained. Thus, the district court deemed evidence of post-breach commercial success to be irrelevant and inadmissible.

The Supreme Court disagreed. Justice Cardozo explained that, because a “patent is a thing unique,” “[t]here can be no contemporaneous sales to express the market value of an invention that derives from its novelty its patentable quality.” Id. at 697. Nevertheless, “the absence of market value does not mean that the offender shall go quit of liability altogether.” Id. If trial is shortly after the breach, “the only evidence [of the patent’s value] may be that supplied by testimony of experts as to the state of the art, the character of the improvement, and the probable increase of efficiency or saving of expense.” Id. at 698. However, if trial is years after the breach, “[e]xperience is then available to correct uncertain prophecy. Here is a book of wisdom that courts may not neglect. We find no rule of law that sets a clasp upon its pages, and forbids us to look within.” Id. Justice Cardozo further explained:

An imaginary bid by an imaginary buyer, acting upon the information available at the moment of the breach, is not the limit of recovery where the subject of the bargain is an undeveloped patent. Information at such a time might be so scanty and imperfect that the offer would be nominal. The promisee of the patent has less than fair compensation if the criterion of the value is the price that he would have received if he had disposed of it at once, irrespective of the value that would have been uncovered if he had kept it as his own.

Id. at 699. Thus, “[t]o correct uncertain prophecies in such circumstances is not to charge the offender with elements of value non-existent at the time of his offense. It is to bring out and expose to light the elements of value that were there from the beginning.” Id. at 698.

Over fifty-five years after Sinclair Refining, the Federal Circuit in Fromson adopted the Supreme Court’s rationale for flexibility – the “book of wisdom” – and applied it to the hypothetical negotiation method of calculating damages under § 284:

The [hypothetical negotiation] methodology encompasses fantasy and flexibility; fantasy because it requires a court to imagine what warring parties would have agreed to as willing negotiators; flexibility because it speaks of negotiations as of the time infringement began, yet permits and often requires a court to look to events and facts that occurred thereafter and that could not have been known to or predicted by the hypothesized negotiators.

853 F.2d at 1575. Indeed, the flexibility offered by the “book of wisdom” is as important in the context patent law as it is in the context of contract law because it discourages infringement. If the hypothetical negotiation could not be informed by post-negotiation information, then prospective infringers might perceive “that blatant, blind appropriation of inventions . . . is the profitable, can’tlose course.” Id. at 1575. In other words, prospective infringers might rationally conclude that, at worst, upon a finding of infringement “a license can be compelled, probably at the same royalty that would have been paid if the patentee’s rights had been respected at the outset.” Id. at 1574. Moreover, the “book of wisdom” prevents the hypothetical negotiation method from determining a reasonable royalty at a point in time before the patent has proven its worth. In doing so, the “book of wisdom” concept protects the quid pro quo arrangement underlying patent law by ensuring that the patentee will be adequately compensated for infringement. See id. at 1575.

Importantly, the plain language of the statute clearly supports the flexible “book of wisdom” approach by ensuring the recovery of “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.” § 284 (emphasis added). It is axiomatic that “the use made” will not be known until after infringement. And since the date of the hypothetical negotiation is “before the infringing activity began,” Integra, 331 F.3d at 869 (emphasis added), information not available as of that date must necessarily be considered by the factfinder. Furthermore, § 284 “does not mandate how the district court must compute [the reasonable royalty], only that the figure compensate for the infringement.” TWM Mfg., 789 F.2d at 899. Thus, the “methodology of assessing and computing damages under [the statute] is within the sound discretion of the district court.” Id. at 898. The only discernable limitations on that discretion are: (1) that the damages be no less than a “reasonable royalty for the use made of the invention by the infringer,” § 284; (2) that the damages adequately “compensate for the infringement,” id.; see also Integra, 331 F.3d at 870 (“Royalties, like lost profits, are compensatory damages, not punitive.”); and (3) that the reasonable royalty be based on “sound economic and factual predicates,” Riles v. Shell Exploration and Prod. Co., 298 F.3d 1302, 1311 (Fed. Cir. 2002).

HSC got shot down in its arguments to the contrary; read that part of the decision beginning on page 8.

Posted by Patent Hawk at July 8, 2005 12:00 AM | Damages

Comments

Where can I find more information on the TWM vs Dura suit? My grandfather was Steve Turner, inventor of the Turner Quick Lift suspension system and was represented by Geoff Myers in this suit.

Posted by: Lori Turner Crawford at August 14, 2008 4:12 PM