Tuesday, August 20, 2013

A Principled Approach to Awarding an Accounting of Profits

Varco Canada Ltd v Pason Systems Corp 2013 FC 750 Phelan J

The remedy of an accounting of profits has undergone a resurgence in Canada since the 1980s, and it is now regularly sought by a successful patentee. There are two major questions that have emerged: (1) what is the basis for the calculation of the quantum; (2) what is the basis for an entitlement to elect an accounting? The first question has been greatly clarified by the landmark SCC decision in Monsanto v Schmeiser, 2004 SCC 34 and the subsequent FCA decision in Monsanto v Rivett FCA 2010 FCA 207 which largely affirmed the approach taken by Zinn J at first instance, 2009 FC 317. Phelan J’s decision in Varco suggests that the Federal Court may be approaching a principled and theoretically sound consensus on the second question.

An accounting of profits is an equitable remedy, and it is therefore discretionary in nature. Standard equitable considerations, such as laches, have traditionally been invoked by a court in deciding whether the plaintiff should be permitted to elect an accounting. While the flexibility of equity is one of its strengths, and a variety of factors may be relevant in particular circumstances, the law has largely lacked an overall principle which would guide the court’s discretion on this point. Some cases have indicated that a patentee will normally be permitted to elect an accounting unless there is some reason why that remedy should be denied (see eg 2006 FC 586, Mosley J [135]), while others have suggested that an accounting will be denied unless the plaintiff can show some positive reason why it should be granted: see eg 2006 FC 1234, Hughes J [132]; 2010 FC 1265, Snider J [617].

In Rivett, Zinn J at [19] cited the SCC's observation in Strother 2007 SCC 24 to the effect that a disgorgement of profits has a restitutionary purpose, which focuses on restoring to the wronged party profit which properly belongs to him, and a prophylactic purpose, which aims to “deter the wrong-doer and others who might emulate his actions.” Zinn J noted that “It is not necessary that both purposes be served in every case” [20], and his analysis of the patent context focused on the prophylactic, or deterrent purpose:

[23] At the level of principle, there is no deterrent from infringing the patent if what the infringer is required to hand over is the sum he would otherwise have paid to Monsanto to buy the seed and the licence. In fact, this would almost be counter to the purpose of deterrence. It is much like saying, as the plaintiffs put it in their oral submission, "Catch me if you can". If caught, the defendant would be required to pay the sum he would have paid to use the patent in any event. When not caught, he is left with a windfall. The accounting remedy would lack any deterrent effect if defendants could use patented technology and retain the profits from such use subject only to paying a license fee as compensation if and when they are caught.

So, the attraction of an accounting is that it provides a deterrent against infringement, because the infringer will be no better off by having infringed. But at the same time, an accounting avoids the risks of over-deterrence, because the infringer is made no worse off than if it had not infringed. Over-deterrence is a real concern, because many granted patents are invalid, and when a litigant successfully challenges an invalid patent, it does a public service. As I argued in my post on Eurocopter 2012 FC 113, punitive remedies, which make the infringer worse off than it would have been had it not infringed, are very problematic because this will deter parties from challenging potentially invalid patents. For this reason, in my view an accounting is much superior as a deterrent than US-style treble damages for wilful infringement. I elaborate on this in my review of Tom Cotter’s Comparative Patent Remedies.

Gauthier J has previously picked up on Zinn J’s reasoning in her cefaclor decision 2009 FC 991, especially at [663], holding that the deterrent objective of a punitive damages had already been weighted in allowing Lilly to elect an accounting, and at [872] where she quoted Zinn J’s “Catch me if you can,” observation. In Varco, Phelan J has wholly endorsed and adopted Zinn J’s approach [399], and elaborated on it.

Phelan J acknowledged that “a plaintiff has to show some basis for the exercise of this equitable relief. It must be more than bare infringement” [401], and he pointed to six factors.

(1)”There has been no inequitable conduct by the Plaintiffs sufficient to disentitle them to equitable relief” [403].

(2) The case involves two competing products, which are almost entirely market substitutes, so that calculation of an accounting is relatively straightforward [404].

(3) The patented functionality, and not the features which distinguished the defendant’s product from the patented invention, was the primary reason for the purchase decision [405].

(4) The defendant deliberately copied the patentee’s product and targeted the same market [406].

(5) The defendant actually knew of the patent and of the risk of infringement [407], [408].

(6) The defendant was a larger company than the patentee and “[t]he prospect of Pason knowing that it had this market power and that it could ‘steamroll’ over its competition cannot be discounted” [409].

These considerations are fully consistent with a deterrence based approach to the election of an accounting.

(1) and (2) are negative, rather than positive considerations; they advert to reasons that might justify denying an accounting which would otherwise be allowed, but they are not reasons in themselves for allowing an accounting.

Factors (3) - (5) are the factors that establish the entitlement, and they all go to the deterrence rationale. Knowledge of the patent is important, because it implies that the defendant could have negotiated for a licence ex ante. This is the factor that goes most directly to Zinn J’s “catch me if you can” point. If a defendant had no knowledge of the patent, then it would not have making a calculated decision that even if it got caught, the remedy would be less than its profit. (3) and (4) imply that the patent remedy would have been a significant factor in the defendant’s decision to infringe. Put conversely, an accounting will be less likely to be awarded when the patented invention is one of many parts in an overall product (3), and the feature was independently developed by the defendant (4), and the defendant was unaware of the patent at the time of infringement (2). These are characteristics that would describe many actions by patent trolls against operating companies, such as NTP v RIM. Thus these factors give the intuitively attractive result that patent trolls should normally be denied an accounting, and confined to damages.

Factor (6) also goes to intent, but it raises a separate question. So far I have been discussing the relationship between an accounting and damages, but what about the relationship between an accounting and punitive damages? I have argued that an accounting is attractive because it provides a deterrent without an over-deterrent, but is there ever room for the “over”-deterrence provided by punitive damages? In a passage which calls to mind Gauthier J’s remarks in cefaclor, Phelan J denied punitive damages:

[469] The Plaintiffs asked for exemplary/punitive damages. Had the remedy been restricted to normal damages, I would have awarded exemplary/punitive damages because of the deliberate infringement carried out in the face of advice from Leier and recklessness as to the consequences.

[470] However, exemplary/punitive damages are equitable relief. The equitable principles have already been embodied in the disgorgement of profits remedy and further equitable relief is unwarranted.

This suggests that an accounting will entirely displace punitive damages, so that if an accounting is awarded, punitive damages will not be. I am not sure I would go so far. I agree that deliberate infringement should not be sufficient to ground punitive damages, because deliberate infringement might be based on a belief that the patent is invalid, and I doubt that conditioning punitive damages on patent validity opinion letters, as in the US, is a satisfactory response to the problem of determining subjective intent. But Phelan J’s sixth factor is different, in that it suggests that the defendant may have believed that it would not be caught, not because the patent was invalid, but because it would be able to drive the patentee out of business or into a settlement, by virtue of its size and market power. To my mind, this begins to approach the behaviour of the defendant in Whiten v Pilot Insurance 2002 SCC 18. While I am of the view that the Canadian courts' dislike of punitive damages in patent cases is well justified, particularly in view of the availability of an accounting, punitive damages in addition to an accounting may sometimes be justified, and perhaps this is such a case.

I have gone on longer than I intended on this sixth point, as it is only a quibble. Phelan J’s decision in Varco, by building on Zinn J’s decision in Rivett, has helped set the question of entitlement to an accounting on a sound principled footing.

(Thanks to Alan Macek's IPPractice blog for posting this decision before it has appeared on the FC website. )

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