Tuesday, November 25, 2014

A New Framework for Determining Reasonable Royalty Damages in Patent Litigation

Following a jury trial in 2012, a US federal district court entered judgment in the amount of $1 billion in favor of Monsanto in a patent infringement dispute against DuPont. The strange thing about this case is that DuPont had not sold any infringing product at all; yes, you are reading correctly – $1 billion in royalties on zero sales. The $1 billion damages award reflected the jury’s best estimate of the lump-sum royalties that would have been agreed to in a hypothetical negotiation taking place just before the infringement began, in which the parties would only have had information available to the parties at that time (“ex ante information”) That DuPont ultimately did not actually sell any infringing product was ignored as being information that would not have been available to the parties at the time of the negotiation (“ex post information”).

Professor Tom Cotter and I have just posted a draft paper on SSRN, "A New Framework for Determining Reasonable Royalty Damages in Patent Litigation," arguing that this result is wrong. More generally, we argue that the hypothetical negotiation used for assessing a reasonable royalty should be assumed to take place at the time of first infringement (or, more precisely, first reliance), but the parties should be assumed to have available to them all the information that was available at trial. We call this the “contingent ex ante” approach; the hypothetical negotiation takes place ex ante, but it is contingent on all information available ex post. We apply our analysis to a variety of contexts, including standard essential patents; unexpected exogenous events (the market value of the invention changes because of unforeseen factors); separate and distinct infringements (when should damages be assessed on the basis of two distinct hypothetical negotiations, rather than one); regulatory uncertainty (when the patented invention received regulatory approach after the time of the first infringement); non-infringing alternatives (when a patent covering an NIA is held to be invalid after the time of the first infringement, but prior to trial), as well as in the context of lump-sum versus running royalties (which raises considerations of risk-shifting, strategic considerations in licensing and the time value of money).

While our discussion focuses entirely on US law, in my view the principles we discuss are equally applicable to Canadian law. Indeed, I suggest the argument is even stronger in Canadian law, for two reasons.

First, our basic argument is that using all available information, including ex post information, better serves the purpose of the Patent Act, which is to provide an incentive to develop inventions for the benefit of the public. Using ex post information allows more accurate determination of the true value of the invention, and so better aligns the patent incentive with the purpose of the Act. While patent damages are often analogized to a species of tort, they are ultimately statutory, and under the modern Canadian approach to statutory interpretation, the statutory provisions should be interpreted in a manner that it consistent with the purpose of the Act. (This makes our argument stronger than in the US, which has not yet fully embraced a purposive approach to statutory interpretation.)

Secondly, our argument is fully consistent with the Canadian approach to tort damages. In Athey v Leonati [1996] 3 SCR 458, the SCC said “past events must be proven, and once proven they are treated as certainties” [28]. This refers to all event prior to trial: “In this case, the disc herniation occurred prior to trial. It was a past event, which cannot be addressed in terms of probabilities” [30]. Most obviously, special damages are assessed on the basis of reasonable expenses that were actually incurred prior to trial, not what expenses the parties might have anticipated would be incurred. The fact that the plaintiff had not in fact suffered any harm as a result of a tort, perhaps because of a miraculously quick recovery, or that she had suffered unusually severe harm (the thin-skull rule), would certainly be considered in a Canadian tort case; we argue that in a case like Monsanto v DuPont, the fact that the infringer had not in fact made any sales should also be taken into account, for essentially the same reasons.

Here is the abstract:

Conventional analysis often assumes that there are only two theoretical options for calculating a reasonable royalty in patent disputes: a "pure ex ante" approach, under which a court reconstructs the hypothetical bargain the parties would have struck prior to infringement, based on the information available to them at that time; and a "pure ex post" approach, under which the court considers the bargain the parties might have reached as of some later date such as the date of judgment. The first approach avoids patent holdup - basing the royalty partly on the infringer's ex post switching costs - but cannot easily explain other longstanding features of how royalties are calculated, and can lead to awards that reflect the parties' erroneous ex ante expectations. By contrast, the pure ex post approach uses more accurate information about the invention's actual value, but it also enables the patentee to capture some of the patent's ex post holdup value. In this Article, we show that a "contingent ex ante" framework, under which the court reconstructs the bargain the parties would have reached ex ante, based on all relevant information that is available ex post, is superior to both of the conventional approaches. More specifically, our framework enables courts to base the royalty on the most accurate information available of patent value while avoiding the holdup risk arising from the pure ex post approach. We analyze how courts can apply our approach in various settings, including cases involving SEPs, sequential infringement, regulatory uncertainty, and unexpected exogenous events.

The paper is available at SSRN. It is a draft, so comments are welcome.

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