Wednesday, April 26, 2017

Can Lost Profits Be Claimed as Reasonable Compensation under 55(2)?

 Dow Chemical Co v NOVA Chemicals Corp 2017 FC 350 Fothergill J
            2,160,705 / film-grade polymers / ELITE, SURPASS

In the liability phase of this action, Dow Chemical Co v NOVA Chemicals Corp 2014 FC 844 aff’d 2016 FCA 216, O'Keefe J held Dow’s 705 patent related to film-grade polymers to be valid and infringed by Nova’s SURPASS product: see discussion of the FC decision here and the FCA decision here. He also held that Dow was entitled to damages under s 55(2) of the Patent Act for pre-grant ‘infringement’, and that Dow was entitled to elect between damages and an accounting for post-grant infringement. Dow subsequently elected an accounting [107]. Fothergill J’s decision in the remedies reference provides helpful clarification on a number of issues. This post discusses reasonable compensation under s 55(2) of the Act.

Dow’s ‘705 patent relates to film-grade polymers, used to make products such as plastic bags, and in particular metallocene linear low-density polyethylene [mLLDPE], which includes both ELITE, manufactured by Dow, and SURPASS, manufactured by Nova. Both these products have superior strength and processing characteristics as compared with conventional linear low-density polyethylene products, and they occupy a distinct market segment from conventional film-grade polymers [15], [92].

Reasonable Compensation
Subsection s 55(2) of the Act provides that “A person is liable to pay reasonable compensation to a patentee . . . for any damage sustained by the patentee,” for ‘infringing’ acts committed between the time of publication and the time of grant [63]. The parties agreed that the proper measure of damages under s 55(2) is a ‘reasonable royalty’ to be determined using a hypothetical negotiation between Dow and Nova for a licence authorizing Nova’s use of the patented technology [64], [65]. To determine the reasonable royalty, the parties used essentially the same framework as was used in Airbus v Bell Helicopter 2017 FC 170 (discussed here), in which the boundaries of the hypothetical negotiation are the patentee’s “minimum willingness to accept” [MWTA or MWA] and the infringer’s “maximum willingness to pay” [MWTP or MWP]. The difference between the two is the “gains to trade,” which are divided between the parties [67].

This approach runs into a problem when the patentee’s MWA is higher than the infringer’s MWP – that is, when there is no price that the infringer would be willing to pay that the patentee would be willing to accept. This is not uncommon, given that it often happens that a reasonable royalty is assessed in favour of a patentee who, in reality, was using the patent to enforce market exclusivity for its own product. The minimum the patentee would accept is its own profit margin on all its lost sales, and it is rare that the infringer’s profit margin will be higher than that the patentee’s margin. This means that in reality, the patentee would not have been willing to licence on any terms the infringer would have been willing to accept. That is what happened in this case. The experts agreed that Dow’s MWA would be the lost profit on sales that would be diverted from Dow to Nova due to the infringing competition [68]. Fothergill J concluded on the facts that Nova’s MWP would be lower than Dow’ MWA. 

So, what to do? Fothergill J held, with the agreement of the experts, that the way to solve this problem is that the reasonable royalty is the patentee’s MWA, i.e., the higher figure:

[87] If Nova’ MWTP is lower than Dow’ MWTA of 8.8%, then there is no bargaining range between the parties. As Dr. Heeb stated, “[s]ince a bargain is compulsory in this hypothetical negotiation, the reasonable royalty rate is simply Dow’ MW[T]A”. Dr. Leonard did not dispute this approach. There is therefore no need to consider the division of gains to trade.

Dow’s MWA was equal to its profit margin on its ELITE product, that competed with the infringing SURPASS [80], [81] (albeit with a “diversion ratio” discount that I will ignore for the present purposes), so in effect Dow was awarded its lost profits on the sales that were diverted to Nova by Nova's use of the patented technology during the laid-open period.

In the context of reasonable royalty damages generally, I think that using the patentee's MWA is the wrong solution to this problem in the hypothetical negotiation framework. The reason, in a nutshell, is that we should never end up in this situation in the first place: if the patentee’s MWA is higher than the infringer’s MWP, this could only be because the patentee’s best option would have been to sell the product itself, in which case it should be seeking lost profits. Very often in this kind of case the patentee does indeed seek lost profit damages, or an accounting of the infringer’s profits, and this problem does not arise. Nor does the problem arises when the infringer was selling to a market that would not have been tapped by the patentee, and so there are no lost profits to prove. That is the classic reasonable royalty scenario, where there are gains from trade and the MWA / MWP approach works well.

But sometimes the patentee is unable or unwilling to prove damages in the form of lost profits in litigation, and so ends up claiming a reasonable royalty, even though in the real world the patentee would have refused a licence, and made its own profits. In that case, allowing the patentee to insist on an MWA that is equal to its own profit margin would allow it to smuggle lost profits damages into a reasonable royalty assessment. Having failed to prove lost profits directly, the patentee shouldn’t be able to get them indirectly, disguised as a reasonable royalty. The problem in such a case is not with the hypothetical negotiation construct, but rather with the assessment of the MWA on the facts. If the patentee did not claim, or failed to prove lost profits, then it should not be able to assert that its MWA would have been defined by those same lost profits: see here for more.

With that said, in this case, I think the approach adopted by the parties, and by Fothergill J, is right. This is not a case in which the patentee failed to claim or prove lost profits. By statute, the patentee was confined to “reasonable compensation,” and the real question is what is meant by “compensation.” Does it include lost profits? On its face, the answer is yes. It is very well-settled that the purpose of patent damages, including lost profit damages, is to compensate the patentee. Compensation is achieved by putting the patentee back in the position it would have been in but for the wrongful act: see e.g. Lovastatin Damages 2015 FCA 171 [41]-[43], [49]-[50]. Section 55(2) also requires “compensation” of the patentee. Prima facie, the term “compensation” in a remedial provision of the Act should mean the same thing that it means in remedies law generally. From that it follows directly that when the patentee has lost profits as a result of the wrongful act, it should be entitled to recover those lost profits in compensation. On this view, the only substantive difference between 55(1) and 55(2) is that, in the former, the wrongful act is infringement of a granted patent, and in the latter, the wrongful act is any act that would have constituted an infringement of the patent, during the laid open period.

The only obstacle to this analysis, which was no doubt the reason that the parties agreed that reasonable compensation should be assessed as a reasonable royalty, and not lost profits, is Snider J’s decision in Jay-Lor 2007 FC 358, in which the patentee also claimed reasonable compensation under s 55(2). The patentee specifically argued that that reasonable compensation should take the form of damages on lost sales, i.e. lost profits [121]. Snider J rejected this:

[122] In my view, such an award is not warranted. In addition to relying on the comments of Justice Gibson in Baker Petrolite, I base this view on my reading of the relevant statutory provisions. For the period after the grant of the patent, s. 55(1) of the Patent Act provides that “a person who infringes a patent is liable . . . for all damage sustained by the patentee”. In contrast, s. 55(2) provides that a person is liable to pay “reasonable compensation . . . for all damage sustained by the patentee” during the laid open period. In s. 55(2), Parliament could have provided for the same assessment of damages as in s. 55(1). It did not do so. Accordingly, to give effect to the different words in the two provisions, I believe that the better view is that “reasonable compensation” during Period 1 must be something other than damages as contemplated by s. 55(1). It may be that there are other means to provide reasonable compensation beyond a royalty. However, in the case before me, no alternatives were presented. Thus, in this case, I intend to equate “reasonable compensation” to a “reasonable royalty”.

With respect, Snider J’s holding on this point is, in my view, wrong. Compare the provisions:

55(1) A person who infringes a patent is liable to the patentee and to all persons claiming under the patentee for all damage sustained by the patentee or by any such person, after the grant of the patent, by reason of the infringement.

55(2) A person is liable to pay reasonable compensation to a patentee and to all persons claiming under the patentee for any damage sustained by the patentee or by any of those persons by reason of any act on the part of that person, [during the laid open period].

The most basic problem with Snider J’s interpretation is that a patentee who has in fact suffered damages in the form of lost profits during the laid open period, and who claims under a provision, s 55(2), that explicitly entitles them to “compensation. . . for any damage,” will nonetheless not be entitled to compensation for its lost profits. This flies in the face of the plain words of the Act. Moreover, Snider J’s view is premised on the need to give effect to the different wording in the two provisions. This implies that if 55(2) had said “A person is liable to a patentee ...” omitting the words "reasonable compensation" then it would include lost profits, because then the provisions would be exactly parallel. So, not only is a patentee denied compensation under a provision that explicitly entitles it to compensation; it is disentitled to compensation because the provision explicitly entitles it to compensation. This strikes me as doubly absurd.

Further, if Snider J is right as a matter of statutory interpretation, the Fothergill J’s holding in this case must also be wrong as a matter of law, because the effect of his decision is to allow a patentee to recover its lost profits during the laid open period. If Snider J’s interpretation of the Act is right, than this would countenance an end-run around a statutorily imposed substantive limitation on recovery under 55(2).

In my view, Fothergill J was right, and that necessarily implies that Snider J’s interpretation of 55(2) was wrong. Ideally, the courts would recognize explicitly that “reasonable compensation” under 55(2) can include lost profits when appropriate on the facts.

But the more important point is that Fothergill J’s holding that when there is no bargaining range between the parties, the reasonable royalty rate is the patentee’s MWA, but it should not be uncritically extended to the context of reasonable royalties. It is acceptable, though not ideal, as a way of avoiding Snider J’s interpretation of 55(2),so long as it is confined to that context. Otherwise, we may have a situation of cascading errors, where a problem in the interpretation of one relatively narrow provisions, gets magnified into a much bigger problem.

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