Patent Time Periods

The three types of patents are divided into two categories based on their longevity: utility and plant patents, and design patents. Utility and plant patents extend for 17 years from the approval date (or 20 years from the filing date – whichever is longer), whereas design patents last for 14 years. The 17‐year time period may be extended up to an additional 5 years for pharmaceutical and medical devices. This extension was made possible by the efforts of the pharmaceutical industry, which was coping with the delays in the Food and Drug Administration approval process.² Once patents expire, the public may freely use the patented product. In the pharmaceutical industry, the expiration of a patent is often followed by a surge of competitors that market generic, bioequivalent drugs at usually significantly reduced prices. Some aggressive generic companies will challenge the validity of a patent prior to its expiration and seek to market a generic. This has led to much litigation as the branded manufacturers fight to maintain their exclusivity on their patented drug.

In the United States the patent granting process begins with the inventor applying to the USPTO. The USPTO assigns the application to a patent examiner. That person then is supposed to compare the invention to prior art so as to determine if it is truly novel and, in general, patentable. The patentee’s claims can be challenged in administrative proceedings wherein parties may claim that the examiner did not consider relevant prior art.

If the patent is granted, the patentee may be able to exclude others from using, or “practicing,” the invention without the permission of the patent holder. It is up to the patentee to enforce the patent. In that enforcement process, the patentee cannot rely on any active assistance from the USPTO.

Changing Legal Framework

The first patent act in the United States was written by Thomas Jefferson and was passed by Congress in 1790. In this initial version of the law, patent time periods were set at 14 years. The time period was extended in 1861 to 17 years. While the patent laws have evolved over the years, including new Patent Acts in 1836, 1870, and 1952, the legal treatment of patents underwent fundamental change in 1981 when the federal court system created a special Court of Appeals of the Federal Circuit. This court exclusively handles appeals of intellectual property lawsuits. This court has issued numerous decisions that have further defined the law in this area.

When an infringer claims a patent is invalid, the court places the burden of proof on the infringer, who must prove the lack of validity. The standard of proof is demanding, but if the use is invalid, the infringer may demand significant damages. This has been underscored by several large damage awards. The costs of engaging in unauthorized use of patents have risen.

The owner of the intellectual property may ask the court for an injunction. However, courts have been somewhat reluctant to grant injunctions. In patent cases, courts require the owner of the patent to meet certain standards, such as a convincing likelihood of success and proof of irreparable harm that outweighs any harm the injunction inflicts on the defendant. The key requirement is likelihood of success, and if this is met, the court may simply presume the existence of other criteria, such as irreparable harm.³ The presumption of irreparable harm is partially based on the fact that a patent is bestowed only for a limited duration and continued use of the patent during that time period will erode the value of the patent to its holder.

Trends in Patent Data Research

In general, the number of patent applications and patents granted grew steadily but modestly from the mid‐1960s through the mid‐1990s. However, roughly by the middle of the 1990s, growth picked up and both remained on a higher growth path until 2015, when both applications and grants declined (see Exhibit 9.1).

PwC, the accounting firm formerly known as PricewaterhouseCoopers, conducts annual research and analysis on various types of lawsuits such as securities and intellectual property lawsuits. Their annual reports on patents are a rich source of data on trends in these areas of litigation.⁴

PwC noted that the trend toward juries being the predominant trier of the facts has been dramatic. For example, over the period 1998–2002, 42% of cases were decided by juries. However, by the period 2013–2017 over three‐quarters (77%) of such lawsuits were decided by juries.

With respect to damages awards, the PwC study found that there really has not been any meaningful increase in the median damages awards. For example, over the period 1998–2002 the median award was $6.1 million. Over the more recent period 2013–2018, that amount was $6.0 million. So the rising volume of lawsuits does not seem to have changed the magnitude of the median award. However, the PwC study showed that patent holders enjoyed a 74% success rate with juries compared to bench trials. In addition, the same study showed that over the five‐year period 2013–2017 the median jury award was $10.2 million compared to $1.9 million in bench trials.

The PwC study also examined the differences in success rates of nonpracticing entities (NPEs), sometimes referred to as patent trolls, compared to practicing entities (PEs). In the context of patents, a nonpracticing entity is one that owns the patent but that has no intention of developing it and individually applying it in commerce other than through litigation. PwC showed that at trial NPEs were less successful then PEs. However, for a given successful outcome, NPEs awards were significantly higher than those for PEs. Their research also showed that the median damages awards given to universities and nonprofits were much higher ($16.6 million) compared to corporations ($11.8 million) or individuals ($7.1 million). Indeed, universities/nonprofits not only enjoyed higher awards but they also had higher success rates (47%) compared to corporations (31%) and individual NPEs (18%).

The PwC 2018 report also showed that Delaware was the most popular patent venue, although the Eastern District of Texas and New Jersey were also very popular venues. In 2017, the U.S. Supreme Court clarified the criteria that can be used to determine the filing venue. Prior to this decision, the Eastern District of Texas had become a patent litigation hotbed. In its TC Heartland LLC v. Kraft Food Group Brands decision, the Court limited the relevant venue to the judicial district in the state where the defendant is incorporated or where the alleged acts of infringement were committed and where it conducts regular business activities.⁵

Patent Trolls

Patent trolls have been responsible for the dramatic increase in patent litigation that has occurred over the past 15 years. However, the impact of the actions of trolls goes well beyond the filing of lawsuits. It is a common practice for trolls to send out large volumes of “demand letters” to hundreds or thousands of firms wherein they assert patent infringement claims, most of which are highly dubious. These letters threaten litigation unless the letter recipients make payments, such as license fees, to the trolls. Cohen, Gurun, and Kominers showed that NPEs tended to target cash‐rich firms, whereas PEs seem not to be motivated by a target’s cash holdings.⁶

While Congress has yet to pass a law limiting such practices, many states, starting with Vermont in 2013, have passed laws limiting the ability of trolls to make bad faith patent claims via such demand letters.⁷ The laws may allow a court to evaluate a troll’s claim and if it is questionable, it may require the troll to post a bond to cover the alleged infringer’s litigation costs. The laws also provide remedies for troll targets in the form of equitable relief, litigation costs, and exemplary damages.

The passage of laws limiting improper actions of trolls seemed to limit some of the adverse economic effects of their actions. Appel, Farre‐Mensa, and Simintzi found that the actions of trolls have had adverse economic effects, including reducing employment.⁸ They found that these effects were most pronounced at start‐ups. They also found that the passage of anti‐troll laws in 32 states resulted in a 4.4% increase in employment at high‐tech start‐ups.

Direct Versus Contributory Infringement

“Direct infringement” refers to the unauthorized use of a patented product. The owner of the patent then has the right to bring an action against the infringer seeking damages. Contributory infringement occurs when one party facilitates the infringement by others. The owner of the patent then has the right to bring an action against the party who made it possible for others to infringe on the patent.⁹ This creates certain opportunities for the patent owner, who may be able to pursue one action against the facilitator rather than pursuing many separate actions against a multitude of infringers (a costlier process).

Defenses Claimed by Alleged Patent Infringers

The users of intellectual property typically claim that they either did not infringe or that the patent is invalid. The lack of validity may be asserted by claiming that the invention was anticipated by a prior art and therefore was not patentable. The defendant may also claim that the United States Patent and Trademark Office failed in its duty to disclose the best prior art or research data that would not have supported the patent.¹⁰

Remedies Available to the Patentee

The patentee has several principal remedies available to it.¹¹ The timeliest of these is the issuance of an injunction, which would bar the infringer from continued use of the patent. The second type of remedy is an award of monetary damages in the form of a royalty or lost profits. In addition, the patentee may also seek compensation for legal fees and court costs.

Computation of Lost Profits

Patent owners can incur lost profits in a number of ways. The most basic lost profits computation is to measure incremental profits. Incremental profits are defined as shown in Equation 9.1.

(9.1)

The incremental profit approach is well established in the patent case law as set forth in cases such as Paper Converting Machine Co. v. Magna‐Graphics Co.:

The incremental income approach to the computation of lost profits is well established in the law relating to patent damages. See Lam, Inc. v. Johns‐Manville Corp.; Levin Bros v. Davis Manufacturing Co., 72 F2d 163 (8th Cir, 1934). The approach that it does not cost as much to produce unit N + 1 if the first N (or fewer) units produced already have paid fixed costs. Thus fixed costs – those costs which do not vary with increases in production, such as management salaries, property taxes, and insurance – are excluded when determining profits.²⁰

Consistent with the general methodology used in other types of commercial damage cases, fixed costs that do not vary with output are usually not included in the profit computation. In an effort to minimize its damages, infringers may focus on the magnitude of its sales of the infringed product as well as the costs included in the patentee’s incremental profit margin.

One major difference between lost profits computations in patent infringement cases and other commercial damages cases is that there are lower requirements for proving demand for the product. The norm is simply to assume that the infringer’s sales would have been the patentee’s. It is usually not necessary to develop a more complete analysis of the demand determinants, which normally would be done in a business interruption analysis. This sidesteps the questions of whether the patentee would have been able to sell as many units as the infringer did (from a demand‐side perspective) and whether the patentee would have received the same price.

Measurement of the Infringer’s Profit’s

Prior to 1946, a plaintiff could recover both his lost profits and the infringer’s profits. The Patent Statute was amended in 1946, though, to prevent the possibility of a double recovery.²¹ The Supreme Court later interpreted the 1946 amendment to provide for the computation of the plaintiff’s pecuniary damages as a result of the infringement.²² The rule in not only patent litigation but also trademark and copyright lawsuits is that the plaintiff can recover its lost profits or the defendant’s profit but not both.²³

The infringer’s profits may not be very relevant to the computation of the plaintiff’s lost profits. The key is determining what profits the patentee would have realized from the sales that the infringer made. However, the infringer’s profits play a role when it is difficult to measure the patentee’s profits. In such cases, the court looks to the infringer’s profits to determine a reasonable royalty.

Lost Profits and Analysis of Market Share

One way that profits are measured in cases where substitutes for the infringed product exist is what is called the market share approach. It is an approach that has been accepted by courts.²⁴ Using this approach, an expert tries to measure the appropriate market share for the plaintiff. This is often done by considering the sales of the plaintiff in relation to the sales of other companies selling in the same market. A historical market share is established, and the expert considers this when trying to establish what the plaintiff’s market share would be “but for” the infringement of the defendant. That is, the expert attempts to create a “but for” market share. The expert cannot do this blindly; he or she also must consider other relevant factors, such as changes in the market and the economy that prevailed during the infringement period. If significant changes have taken place in the market and the economy such that the plaintiff would have had a different market share even in the absence of the infringement, then these factors need to be considered.

Market share analysis is simpler for a two firm, or duopolistic, market structure. Here the plaintiff may assert that all of the sales it lost went to the infringer.²⁵ When there are multiple competitors the expert may need to do an analysis of the size of the market as well as the shares of both the infringers and possibly non‐infringers. Economists often analyze market share in antitrust lawsuits but such analysis may also be relevant in intellectual property cases.

The ability of the expert to do such an analysis is partly a function of being able to access reliable data on market size and shares of its participants. When the market includes a number of closely held firms, determining market shares may be more challenging. Sometimes industry reports exist that follow the market and the sales of the major companies in the industry. Prior to using such data, the expert needs to investigate how the data were gathered and compiled by the entity conducting the study.

In computing market share, experts need to be cognizant of any relevant submarkets that may exist. For example, as the court explained in BIC Leisure Products, Inc. v. Windsurfing Int’l, Inc., if the plaintiff and defendant compete in different segments of the market, such as one marketing to “upper end” customers and the other to “lower end,” then it is possible that the plaintiff has not even lost any sales because the two do not necessarily compete directly against each other.²⁶

Comment on Capacity Considerations

The Panduit factors indicate that the plaintiff must show that it had the capacity and capability to produce and market the products whose sales the expert projects. This involves a consideration of several factors. One would be the physical facilities of the plaintiff – its total capacity. The damages expert may have to involve other experts to assist in this task if such an analysis requires this type of expertise. Each case dictates its own requirements. However, the expert needs to be aware that capacity includes more than physical facilities. Each business has a production function whereby it utilizes various inputs to generate an output. The input may include labor, management, equipment, facilities, and the like. The company must be able to realistically integrate all of these components at the projected output level. This is easier to do if it can be shown that the company successfully produced and marketed at that level in the past. If it had capacity constraints that indicate a lower capability than the projected level, then the expert must be able to show that this additional capability could have been acquired successfully, such as through the use of subcontractors. Any changes in the level of profitability at the above‐capacity level also need to be considered.

Lost Profits Due to Price Erosion

Courts have long recognized the concept of price erosion damages.²⁷ They stem from the fact that in addition to being deprived of the profits on sales made by the infringer, the profits actually received by the patentee could also be adversely affected by the infringer’s actions. Had the infringer not entered the market with its unauthorized products, the owner would hold a monopoly position. As a monopolist, it would have the ability to pick the price‐quantity combination on the product’s demand curve that maximized its profits. However, when the infringer enters the market, the price may be affected, as the owner and the infringer become competitors. This can lead to another form of losses – reduced prices received by the owner for the products actually sold. This is shown in Exhibit 9.2, where the increased output due to the entrant of the infringer causes a movement down the product demand curve from q₁ to q₂. As the court said in Crystal Semiconductor Corp. v. Tritec Microelectronics, Int’l, Inc., “all markets must respect the law of demand.”²⁸ A lower price of p₂ also results instead of the price associated with output level q₁ (which would have been p₁). The lower prices erode the owner’s profit margin, leading to lower profits on the sales actually made by the owner.

It may be difficult to precisely measure the price effect that results from the duopolistic market structure (two sellers) in which the owner and the infringer are competitors. However, the court in Kaufman Co. v. Lantech, Inc. eased the burden of proof when measuring lost profits in a duopolistic market structure; it concluded that “when the patentee and the infringer are the only suppliers present in the market, it is reasonable to infer that infringement probably caused the loss of profits.”²⁹ The improper competition changes the marketplace and economists have to estimate what the monopolist’s price would have been in the absence of the competition. Economists have theoretically tried to trace the competitive effects of duopolists through game theory techniques that analyze the interactive effects of competitors.³⁰

In Polaroid Corporation v. Eastman Kodak Company, the court explicitly recognized the need to consider the impact on the plaintiff’s quantity sold due to the higher prices that the plaintiff claimed it would have received had it not been for the actions of the defendant.³¹ In fact, the court rejected the view that Polaroid could have made more money if it had been able to raise prices:

… I find that the higher prices that Polaroid says it would have charged would have depressed demand so substantially that the strategy the company historically pursued is actually the more profitable one.

Polaroid tried to prove its price erosion damages through an econometric model developed by one of its experts, Dr. Franklin Fisher. He concluded from his econometric analysis that from 1976 to 1990, Polaroid could have sold all of the cameras it had sold during this historical period plus all of the ones that Kodak sold while charging higher prices. The court summarized Fisher’s model in this way:

Professor Fisher constructed a model reflecting his judgments about what influences the demand for instant cameras and film…. Professor Fisher arrived at his model just as Professor Baumol did: by making assumptions about the influences on demand, entering the historical values of these influences and arriving at a mathematical relationship between the influences and the number of cameras that were purchased. Professor Fisher went one further step and used this framework of relationships to predict the future.

In Professor Fisher’s model, Polaroid charges more in the Kodak‐free world and yet sells the same number of cameras from 1976–1990 that Polaroid and Kodak sold together from 1976–1985.

I find that Polaroid would not have been able to raise its prices significantly without greatly reducing demand. Not surprisingly, Professor Fisher reaches a different conclusion…. Professor Christiansen, the econometrician who testified for Kodak, dissected the intricacies of Professor Fisher’s model and exposed its unstated assumptions, biases and errors.

By not capturing the profound effect on the competition from conventional products, Professor Fisher overestimated the prices Polaroid could have charged for instant products.

The plaintiff’s unsuccessful attempt to prove price erosion damages in Polaroid v. Kodak shows that any plaintiff must be able to reconcile claims of price erosion damages with the expected downward slope of a typical demand curve. If the plaintiff expects to prove a counterintuitive result, it must be armed with a sound analysis that is going to withstand the challenges by equally qualified experts. Among the issues that have to be convincingly addressed is the price elasticity of demand over the relevant price range.³² The need to address such issues through thorough economic analysis was clearly articulated by Judge Frank Easterbook in Mahurkar. He criticized the lack of a meaningful economic analysis to support price erosion claims but also sought to substitute his own considerable knowledge of economics to try to determine what the relevant price elasticities were.³³

Graphical Depiction of Lost Profits Inclusive of Price Erosion Damages

Losses from the sales of an infringer are shown in Exhibit 9.3. They are shown to include a component for price erosion damages, the difference between PNI PI for all units that would have been sold without infringement, QNI, as well as the units that are sold with infringement, QI. The dotted area, PIGCD, denotes the profits that the infringer realizes with the infringement. It can be seen that, given the way the graph is drawn, these are well below the profits the patentee would have realized without the infringement – PNI AEJ.

Lost Profits Due to Changing Cost Conditions

Another less obvious way the owner can incur lost profits is by not realizing some of the economies of scale that it would have enjoyed had it been in a monopoly position (as opposed to the duopoly that would result from the owner being in competition with one infringer). Whether such losses exist depends on the cost function of the owner. Assume the owner’s production process is characterized by economies of scale, such as that which is reflected in the average cost function depicted in Exhibit 9.4. Then, producing an output such as Q₁ where per‐unit costs are AC₁ (as opposed to a higher output Q₂ where per unit costs are AC₂) results in higher costs equal to the (AC₂ – AC₁)Q₁.

Types of Royalties

There are two types of royalties: running royalties and lump sum royalties. Running royalties are variable costs that are computed either as a percent of revenues or as a simple per‐unit cost. An example of a running royalty is the 8% of infringing sales that was established in H.K. Porter Co. v. Goodyear Tire & Rubber Co. based on expert testimony.³⁴ Lump sum royalties are a fixed sum that the user pays the owner. They give certain rights of use to the user in a manner that does not vary with the volume of use. An example of a lump sum royalty is the $2,600 annual fee per furnace that was established in Trio Process Corp. v. L. Goldstein’s Sons, Inc. based on a prior and existing license.³⁵

Running royalties have certain efficiency effects on the market in that their variable nature is a factor that the user considers when determining its optimal profit maximizing output. If this causes the user to put a lower output on the market than what it would in the absence of these additional variable costs, then economic theory indicates that a less than socially optimal output reaches the market. In this sense, the lump sum royalty is more economically efficient; it transfers some of the profits that the user enjoys from selling its profit‐maximizing output from the user to the owner without affecting the price‐output combination. This is due to the fact that it is a sunk cost and thus should not affect decisions at the margin.³⁶

Reasonable Royalties

The computation of royalties in patent infringement cases is different from the same computation in the normal operation of commerce. In patent cases, the standard is a reasonable royalty – not necessarily a commercially acceptable royalty. Courts have recognized that the computation of such an ex‐post royalty is a legal fiction.³⁷ However, courts have applied a willing buyer–willing seller approach to try to derive a more analytical approach to deal with the fact that there really was not an agreed‐upon transaction, which is part of the reason why there is a lawsuit.³⁸ In seeking to apply this willing buyer–willing seller reasoning, the court in Ellipse Corp. v. Ford Motor Co. explained its reasoning of what such a negotiation process would be like in a manner that is very similar to a discussion of supply and demand curves that one would find in an economics textbook:

In applying the willing buyer–willing seller rule, the court determines, in light of the facts and circumstances at the time of the hypothetical negotiations, the maximum that a willing licensee would have been willing to pay for a license and the minimum that a willing licensor would have accepted.³⁹

One of the factors that courts are concerned about in applying the supply‐demand calculus in an effort to determine a reasonable royalty is whether the resulting number provides sufficient incentives for companies to avoid infringing:

Historically, the methodology has been problematic as a mechanism for doing justice to individual, non‐manufacturing patentees. Because courts routinely denied injunctions to such patentees, infringers could perceive nothing to fear but the possibility of a compulsory license at a reasonable royalty, resulting in some quarters in a lowered respect for the rights of such patentees and a failure to recognize the innovation‐encouraging social purpose of the patent system.

Thus a cold, “bottom line” logic would dictate to some a total disregard of the individual inventor’s patent because: (1) ill‐financed, he probably would not sue; (2) cost of counsel’s opinion could await suit; (3) the patent may well be held invalid on one of many possible bases; (4) infringement may not be proven; (5) if the case be lost, 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. Though the methodology must on occasion be used for want of a better, it must be carefully applied to achieve a truly reasonable royalty, for the methodology risks creation of the perception that blatant, blind appropriation of inventions patented by individual, nonmanufacturing inventors is the profitable, can’t‐lose course.⁴⁰

In Panduit Corp. v. Stahlin Brothers Fiber Works, Inc., the court echoed similar concern:

The setting of a reasonable royalty after infringement cannot be treated, as it was here, as the equivalent of ordinary royalty negotiations among truly “willing” patent owners and licensees. That view would constitute a pretense that the infringement never happened. It would also make an election to infringe a handy means for competitors to impose a “compulsory license” policy upon every patent owner.⁴¹

When a reasonable royalty is not sufficient to compensate the patent holder, courts may allow additional damages beyond the royalty. This was the case in Maxwell v. J. Baker, Inc., where the court concluded that the infringer’s activities damaged the ability of the plaintiff to benefit from its own licensing program.⁴²

A royalty may be computed even when the patent owner has not expressed any desire to license the product. Courts have recognized that the resulting royalty may be one that neither party would contend at trial that it would accept.⁴³ The goal is to compute a royalty high enough to compensate the plaintiff who suffered due to the infringer’s actions. However, in searching for a magnitude sufficient to compensate the plaintiff, courts have gone so far as to accept royalties that not only are greater than the standard royalties that prevail in commercial transactions but that have been as much as 50% of the product’s price and more than 100% of the expected profits.⁴⁴ It seems that once the court concludes that the infringement has taken place, it moves to give the benefit of the doubt to the patentee.

Factors to Consider in Determining Royalties

The Panduit court referred to Georgia Pacific Corporation v. U.S. Plywood‐Champion Papers, Inc., a case in which that court delineated 15 factors that should be considered when determining a royalty rate. The court states that it derived these factors from several leading cases. In Georgia Pacific, the parties stipulated that a reasonable royalty was the proper measure of damages. The Georgia Pacific factors are:

1. The royalties received by the patentee for licensing of the patent in suit, proving or tending to prove an established royalty.
2. The rates paid by the licensee for the use of other patents comparable to the patent in suit.
3. The nature and scope of the license, as exclusive or nonexclusive; or as restricted or nonrestricted, in terms of territory or with respect to whom the manufactured product may be sold.
4. The licensor established a policy and marketing program to maintain his patent monopoly by not licensing others to use the invention or by granting licenses under special conditions designed to preserve that monopoly.
5. The commercial relationship between the licensor and the licensee, such as whether they are competitors in the same territory in the same line of business; or whether they are inventor and promoter.
6. The effect of selling the patented specialty in promoting sales of other products of the licensee; the existing value of the invention to the licensor as a generator of sales of his nonpatented items; and the extent of such derivative or conveyed sales.
7. The duration of the patent and the term of the license.
8. The established profitability of the product made under the patent; its commercial success; and its current popularity.
9. The utility and advantages of the patent property over the old modes and devices, if any, that had been used for working out similar results.
10. The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those that have used the invention.
11. The extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.
12. The portion of the profit or of the selling price that may be customary in the particular business or in comparable businesses to allow for the use of the invention or analogous inventions.
13. The portion of the realizable profit that should be credited to the invention as distinguished to nonpatented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.
14. The opinion testimony of qualified experts.
15. The amount that a licensor (such as the patentee) and a licensee (such as the infringer) would have agreed upon (at the time the infringement began) if both had been reasonably and voluntarily trying to reach an agreement; that is, the amount which a prudent licensee – who desires, as a business proposition, to obtain a license to manufacture and sell a particular article embodying the patented invention – would have been willing to pay as a royalty and yet be able to make a reasonable profit and which amount would have been acceptable by a prudent patentee who was willing to grant a license.

Lost Profits Versus Royalties

As noted, courts view lost profits as the preferential measure of damages in patent infringement cases. As stated in Hansen v. Alpine Valley Ski Area, Inc., “If the record permits the determination of actual damages, namely, the profits the patentee lost from the infringement, that determination accurately measures the patentee’s loss. If actual damages cannot be ascertained, then a reasonable royalty must be determined.”⁴⁵

Plaintiffs may prefer lost profits if they exceed a reasonable royalty. Plaintiff’s counsel may want to compute the losses both ways in advance of a trial as part of the selection of the best damages strategy to pursue. However, the court in Hartness International, Inc. v. Simplimatic Engineering Company endorsed using lost profits as the preferable method with a reasonable royalty being used “when actual lost profits cannot be proven.”⁴⁶ Other courts have stated that the reasonable royalty should merely be used as the floor for damages.⁴⁷ Therefore, damages need to be computed using both approaches. In fact, there are cases where both lost profits and royalties have been awarded.⁴⁸

Using a Simple Rule of Thumb

Some have advocated using a simple 25% rate of expected profits for the product that uses the intellectual property.⁴⁹ When using this “rule,” the profits in question should be “fully loaded.” In computing these fully loaded profits one would start off with gross profits and then deduct other expenses associated with the product. These will vary by case. Logically, they would include selling and marketing expenses as well as research and development expenses specific to the product. Other costs may apply.

One of the criticisms of this rule of thumb is that it is arbitrary even though it may apply in a number of instances. It also does not really consider the value of the patented technology relative to the overall value of the product. Such considerations may draw scrutiny in a Daubert process.

Entire Market Theory

The entire market theory is the view that damages should be computed based on the market for an entire product that contained the infringed product. This means that if the infringed product is a component in an overall product, the patent damages should be computed based on the market for the overall product. Courts may look to applying the entire market theory in cases where the infringed product plays a very large role in determining the value of the overall product.⁵⁰ This usually means that the products are physically part of the same machine.⁵¹ Under the entire market value rule, damages are recoverable on the value of a patentee’s entire apparatus containing several unpatented features where the patent‐related feature is the “basis for consumer demand.”⁵² In addition, the plaintiff may be able to claim damages resulting from lost sales of products that compete with the infringer’s products.⁵³ Such an expanded base for damages can significantly increase the damages resulting from infringement. The U.S. Court of Appeals’ articulation of the entire market theory is shown in an excerpt from Rite‐Hite Corporation v. Kelley Company:

Based upon the “entire market rule,” the district court awarded lost profits on 1,692 dock levelers that it found Rite‐Hite would have sold with the ADL‐100 and MDL‐55 restraints. Kelley argues that this award must be set aside because Rite‐Hite failed to establish that the dock levelers were eligible to be included in the damage computation under the entire market rule. We agree.

When a patentee seeks damages on unpatented components sold with the patented apparatus, courts have applied a formulation known as the “entire market rule” to determine whether such components should be included in the damage computation, whether for reasonable purposes, [citations omitted]. Early cases invoking the entire market rule required that for a patentee owning an “improvement patent” to recover damages calculated on sales of a larger machine incorporating that improvement, the patentee was required to show that the entire value of the whole machine, as a marketable article, was “properly and legally attributable” to the patented feature [citations omitted]. Subsequently, our predecessor court held that damages for component parts used with a patented apparatus were recoverable under the entire market rule if the patented apparatus “was of such paramount importance that it substantially created the value of the component parts” [citations omitted]. We have held that the entire market rule permits recovery of damages based on the value of a patentee’s entire apparatus containing several features when the patent‐related feature is the “basis for consumer demand.”⁵⁴

The Rite‐Hite decision broadened the measures of damages that may be claimed in patent lawsuits. The decision effectively allowed the recovery of damages for lost sales of goods not protected by the patent in suit.⁵⁵ Some have said that this decision could deprive the accused infringer of its day in court while allowing the patentee to unlawfully extend the term and scope of protection of its patents.⁵⁶ Regardless of whether the decision will have such a far‐reaching impact, it is clear that, under certain circumstances, Rite‐ Hite expanded the scope of damages that an expert may consider in such a calculation.⁵⁷ Collateral devices not covered by the patent but normally sold with the patented device now can be included in the damages analysis.

The entire market theory as articulated in Rite Hite found further support in later decisions, such as Lucent Techs, Inc. v. Gateway, Inc. where the court concluded that an entire apparatus should be considered if the patented feature constituted the basis for the demand by buyers.( ^* )

In more recent years other decisions have weakened the entire market theory. In VirnetX, Inc v. Cisco Sys, Inc., the Federal Circuit required the patentee to differentiate between the patented and unpatented features of the product in question and to apportion the damages to just the patented features.( ^** ) In reaching this conclusion that court encouraged the apportionment to be focused down to the smallest saleable unit.

Computer Software

When the laws relating to intellectual property were first written, the computer industry was not near its current size. The computer software industry has since exploded. Given the valuable nature of proprietary computer software, companies want to protect and regulate its usage. In 1981, the U.S. Supreme Court removed legal barriers that had kept software from receiving some of the same protection of patent laws that other products enjoy. After that decision, computer software was protected by a patent. However, owners of the software may also choose to protect their assets through copyrights or as a trade secret.

Copyright Time Periods

Copyrights are protected for the life of an author plus 70 years. However, in the case of “works for hire,” copyright protection lasts 95 years from the date of publication or 120 years from the date of creation. When the copyright expires, the copyrighted material can then be freely used by the public.

Remedies for Copyright Infringement

The Copyright Act provides various remedies for copyright violations, including injunctions, impoundment, or destruction of the infringing items as well as damages. An injunction may be granted when the copyright owner can demonstrate a realistic likelihood of success in the action along with an expectation that the owner will incur irreparable injury. Irreparable injury normally means that damages cannot be adequately compensated for, due to either their magnitude or the uncertainty in measurement. Courts, however, often simply presume the existence of irreparable damages, leaving the defendant to prove otherwise.

Introduction to the Economics of Copyright Law

An analytical framework for the economics of copyright law has been developed by William Landes and Richard Posner.⁵⁸ An overview of this framework is:

• LetP = price of a copy
• q(P) = market demand for copies of a work
• X = number of copies an author produces
• Y = number of copies copiers produce
• Z = the level of copyright protection

Z ≥ 0 is a function of:

1. Degree of similarity between two works before infringement is determined
2. Elements of the work that are protected
3. Period of time work is protected

Assume:

1. Copiers supply copies up to point where P = MC (marginal cost).
2. MC increases as the number of copies increases and level of copyright protection increases.

We can then show the copier’s supply curve as follows:

(9.2)

Author’s profits are:

(9.3)

Substitutes for X:

(9.4)

where:

• e(z) = the author’s cost of expression; the greater the copyright protection is, the higher the author’s cost of expression.

Let’s assume that:

• R = author’s gross profits
• N = number of works created
• N = N(R, Z)

where:

• N_r > 0 and N_z < 0

The net effect in N of an increase in copyright protection depends on two effects:

1. As R increases, the number of works increases.
2. As Z increases, the number of works decreases.

At low Z, there is little incentive to produce works; free riders will dominate. Therefore, N increases as Z increases up to some level – Z*. Beyond Z* there are adverse effects on other potential authors. Some protection is good, but too much protection is bad. The solution is to find optimal Z*.

Landes and Posner go on to show the welfare implications in deriving Z*. Other conclusions of their framework are:

• At Z*, the producer and consumer surplus per work exceeds the cost of producing the marginal work.
• Optimal copyright protection should be set below the level that maximizes the number of works created.
• The more valuable the work, the greater the optimal amount of copyright protection, as the cost of copying relative to the value received from copying will decline.

Defenses in Copyright Suits

A defendant may assert various different defenses in copyright infringement lawsuits. One of the most fundamental is to assert that the copyright is invalid. This invalidity may be based on different theories, such as saying that the copyright was not sufficiently original. Another defense is the “fair use” defense in which the defendant is claiming that it is allowed the limited usage of the copyrighted material. Examples include newscasts, critics, research, and other normal usage. Whether such a defense is effective depends on the context within which the copyrighted material is used. Courts consider various factors, such as the amount of the copyrighted material that was used. The more limited the use, the better the defendant’s position is. Other factors are whether the material is essentially factual or fictional. The more it is a recitation of facts, the better the defense may be.

Copyright Owner’s Lost Profits

The plaintiff’s lost profits usually are measured by the plaintiff’s lost sales less any cost savings from not producing these products. However, the plaintiff must measure these lost sales in a nonspeculative manner. The copyright owner cannot simply assume that the defendant’s sales would have been its sales. Courts have held that various factors, such as the sales prices of both companies, need to be considered in the lost revenue projection process.⁵⁹ In cases in which the defendant sold the infringed product to the plaintiff’s own former customers at similar prices, the assumption that the defendant’s sales would have been the plaintiff’s becomes easier for a court to accept.

In projecting lost sales due to copyright infringement, the forecasting methods discussed in Chapter 5 are useful. Indeed, courts have accepted significantly more basic projection techniques than those previously explained. For example, in Taylor v. Meirick, the court accepted a simple computation of the plaintiff’s average sales for the two‐year period prior to the infringement, without inflationary adjustment, as a nonspeculative forecast of what the plaintiff’s sales would have been for the three‐year infringement period.⁶⁰ Lost sales were then computed as the difference between these projected sales and the owner’s actual sales. The simplistic nature of the damage estimation process is depicted in Exhibit 9.5.

Defendant’s Profits

In order to prove the defendant’s profits, the copyright owner only has to prove the infringer’s gross revenues.⁶¹ Once this figure is known, the defendant then has to establish what its costs are. Defendants may try to present a fuller definition of its costs than what plaintiffs would prefer. At this point, the issue comes down to a cost analysis, and the services of a good cost accountant can be invaluable. If, however, the defendant did not enjoy any profits from the infringement, then there are no profits to award and the damages are simply the plaintiff’s lost profits.

The analysis of the defendant’s profits can be complicated when the costs attributable to the infringed product and the defendant’s other costs that are not related to the infringed product cannot be easily separated. As with other types of lost profits analysis, the goal is to measure the incremental costs associated with the incremental revenues generated from the infringement. In Deltrak, Inc. v. Advanced Systems, Inc., the court recognized that fixed costs, such as rent or depreciation, generally should not be included in this computation.⁶² However, other courts have found that overhead costs, which were measured by a simple overhead costs/revenue ratio, should be applied to gross profits as an allowable deduction.⁶³ An excerpt from the court’s opinion in Deltrak v. Advanced Systems, Inc., a case where the plaintiff sued for the improper use of architectural plans, which were used to build an apartment complex, is instructive in that it states what one court found to be reasonable cost deductions:

In consideration for the construction of the apartment complex and garage located at 1830–32 Knox Street, Empire paid Belmont $512,569 ($511,520 contract price plus $1,309 in reimbursed expenses). Belmont introduced evidence showing that it incurred $451,450.56 in direct deductible expenses, thus realizing a gross profit of $59,709.44 on the project. Belmont contends that it is entitled to deduct from the gross profit a portion of its administrative and general overhead expenses by a formula which would reduce its gross profit to a net profit of $12,878.94.

The rule is that overhead expenses which assist in the production of an infringing work are deductible from the gross profit of the infringer [citation omitted]. The burden is upon the defendant infringer to prove the actual expenditures for ordinary overhead and a fair method of allocating the overhead to the particular infringing activity in question [citation omitted]. The defendant need not, however, prove that each item of overhead was used in connection with the infringing activity [citation omitted].

The law requires no such minutiae, for it would make trial interminable. When appellant proved the actual expenditures for ordinary overhead, and a fair method of allocation, it carried its burden in the first instance. If, on cross examination or otherwise, it appears that ordinary overhead is not chargeable, in whole or in part, to the infringing business, then a proper charge only should be made. But all allowance should not be denied because stenographers, bookkeepers, janitors and presidents were not called to testify that they did perform specific tasks on this specific business. Courts and accountants resort to allocation to obviate this particular difficulty.

Statutory Damages

When the plaintiff’s lost profits and the defendant’s profits cannot be measured in a nonspeculative manner, the courts will look to an award of statutory damages. A plaintiff may elect to pursue statutory damages instead of its lost profits and the defendant’s profits.⁶⁴ Statutory damages are bounded within the monetary limits of greater than or equal to $750 but less than or equal to $30,000 for each infringement. However, in cases where the courts find that the infringer was not aware of its infringement, it may reduce the statutory damage award.

Trademark Time Periods

Trademarks have been defined by the Trademark Act of 1946. A trademark is valid for 10 years with 10 year renewal terms. The holder of the trademark, however, must attest to its continued use between the fifth and sixth year of its life lest the registration be canceled.

Economics of Trademarks

The main economic benefit of trademarks is that they reduce consumers’ search costs. Since the trademark is clearly identified with the marketer of the product, it is in the interest of the trademark owner to invest resources in maintaining the quality of the product or services. Landes and Posner express this in the form of a simple economic model:⁶⁸

where:

• Π = the full price of a good
• P = the money price
• H = search costs incurred by buyers
• T = trademark
• Y = a vector of factors other than T that affect search costs. These include advertising, value of consumers’ time, number of competing products, etc.
• W = availability of words and symbols that can be used to construct a trademark (this is usually not relevant).

Landes and Posner show that firms with stronger trademarks (T) have lower search costs (H) and are able to command higher prices (P) due to the fact that the lower H is, the higher P can be without causing Π to change from its optimal level.

Trade Dress

An area related to trademark infringement is trade dress. Trade dress refers to the physical features of the product that have become known in the marketplace to be associated with a particular marketer of that product. These features signify what the source of the product is. One example is the pink color of Owens Corning Fiberglas insulation.⁶⁹ When trade dress protection is afforded to a product, other companies are barred from duplicating these features. It is even possible for a company to qualify for trade dress protection on a product that was once patented but for which the patent has expired with the passage of time.

Survey Evidence

In trademark litigation, the parties may seek to introduce evidence from surveys on issues such as confusion by consumers. Courts have accepted such evidence, assuming it is found to be reliable and that the individuals designing the survey have sufficient expertise to do so. The opinion of the court in Louis Vuitton Malletier v. Dooney & Bourke, Inc., is instructive:

Survey evidence is generally admissible in cases alleging trademark infringement under the Lanham Act, 15 U.S.C.S. § 1057 et seq. To assess the admissibility of survey evidence, the court should consider a number of criteria, including whether (1) the proper universe was examined and the representative sample was drawn from that universe; (2) the survey’s methodology and execution were in accordance with generally accepted standards of objective procedure and statistics in the field of such surveys; (3) the questions were leading or suggestive; (4) the data gathered were accurately reported; and (5) persons conducting the survey were recognized experts. While errors in survey methodology usually go to weight of the evidence, a survey should be excluded under Fed. R. Evid. 403 when its probative value is substantially outweighed by its prejudicial effect or potential to mislead the jury. Thus, a survey should be excluded under Rule 403 when it is so flawed in its methodology that the survey proves little and the jury is very likely to be misled. Fed. R. Evid. 702 is applicable as well because the result of a survey is essentially expert testimony, and Rule 702 requires that such testimony must be reliable. If a survey suffers from substantial methodological flaws, it will be excluded under both Fed. R. Evid. 403 and Fed. R. Evid. 702.⁷⁰

In this case, the court did not accept the survey put forward by Louis Vuitton due to numerous flaws it saw in the methodology.

Damages for Trademark Infringement

Owners of trademarks can recover their damages (possibly in the form of a royalty) as well as the infringer’s profits. In addition, they can recover other monetary relief, such as treble damages, legal fees, and litigation costs. As with patent damages, lost profits must be proven in a nonspeculative way. Courts place the burden of proof on the plaintiff when it is trying to establish its damages. However, when the defendant’s actions have made it difficult for the plaintiff to measure its damages, the defendant is generally not allowed to profit from this, nor use this as a defense.

Recovery for damages from trademark infringement requires that the trademark owner demonstrate that it has been damaged, be able to measure these damages, and convincingly draw a causal link between the defendant’s action and these damages.⁷¹ A trademark owner is allowed to recover both its lost profits and the defendant’s profits – but not when these come from some of the same sales.⁷² If the plaintiff contends that the infringement caused confusion in the marketplace, resulting in it not being able to make certain sales, it must be able to demonstrate the ability to generate such sales in the marketplace in the absence of such confusion. If it cannot due to, for example, insufficient resources, then the court may not award the owner those damages.⁷³

In establishing damages for trademark infringement, there is a high degree of proof required in establishing that damages actually occurred.⁷⁴ However, once this has been established, the courts are more lenient in the measurement of the actual damages; they may not require exactness. Courts have recognized that economic factors, such as the impact of the competition between the plaintiff and the defendant, may distort the market, making it more difficult to measure the plaintiff’s lost sales.⁷⁵

Plaintiff’s Damages from Trademark Infringement

A trademark owner can be damaged in several ways when its trademark is violated. Sales can be diverted from the owner to the infringer. In addition, if the goods are produced in an inferior manner and the consumer believes that they are the products of the owner, the reputation of the owner may suffer, resulting in diminished future sales. Other damages can occur from the owner using its marketing resources to build up a brand from which the defendant benefits without having to incur these costs. Ironically, the owner may then have to invest even more advertising and marketing monies to correct the consumer’s perceptions. Such corrective advertising is another area in which the damage expert can be helpful.

Patents Versus Trade Secrets: Time Periods and Anticompetitive Effect

The time periods of patents and trade secrets differ. “A patent is distinguished from a trade secret in that a patent is totally exclusionary for a period time for which it is granted; there are necessarily substantial anticompetitive effects. An ordinary trade secret, however, is not totally exclusionary; it is protected as long as competitors fail to duplicate it by legitimate, independent research.”⁸²

Damages for Misappropriation of Trade Secrets

There are two alternative measures of damages for trade secret misappropriation: the plaintiff’s lost profits and the defendant’s gain. The plaintiff can recover one but not both. In order for the plaintiff to prove its losses, it may need to prove causality as well as the magnitude of damages.⁸³ Causality also involves showing that the sales diverted to a competitor would have been the plaintiff’s sales “but for” the misappropriation of the trade secret.⁸⁴

Trade secret damage analysis presents some interesting economic and accounting issues. For example, if the secret was the product of costly research, the defendant may be able to undercut the plaintiff’s prices and take market share from the plaintiff. This could have an extended impact on the plaintiff if consumers are reluctant to pay the plaintiff’s higher prices in the future.

In order to measure the defendant’s profits derived from the use of the trade secret, an accounting of the defendant’s profits attributable to the use of the secret needs to be compiled. Depending on the nature of the secret, it may or may not be easy to segregate these sales and profits from the other sales and profits of the defendant. Once the defendant’s profits are measured, a court can consider remedies such as restitution. Another remedy is a royalty; however, it is not often used.⁸⁵ Royalties are used in trade secret cases when the plaintiff cannot prove its losses. In Carter Products, Inc. v. Colgate Palmolive Company, the court awarded royalties that were computed as a percent of the defendant’s sales in addition to the defendant’s profits.⁸⁶ Royalties may also be used when the defendant did not make a profit from use of the misappropriated secrets.⁸⁷

Measuring the Plaintiff’s Losses in Misappropriation of Customer Lists

The analysis of losses due to misappropriation of customer lists has to do with the measurement of the plaintiff’s losses and the defendant’s gains from sales to customers on the misappropriated lists. In Jet Spray Cooler, Inc. v. Crampton, the court stated that the plaintiff may not recover both his own lost profits and those of the defendant.⁸⁸ This makes sense, because, “but for” the misappropriation, the sale would not have been made twice (although a given customer could be sold to more than one time). The defendant may try to prove that the plaintiff would not have made the particular sales that the defendant made. The burden of proof for this is on the defendant. In Michel Cosmetics v. Tsirkas, the court considered the trend in the plaintiff’s sales and noted that its revenues and profits did not fall after the misappropriation. The court further noted that the sales were not even made in the plaintiff’s territory.⁸⁹

One factor that needs to be considered in lost customer cases is the length of the projection. For long‐term projections, the rate of customer attrition needs to be considered. The attrition rate and average customer duration is discussed in Chapter 5.