Legal Fees Not a Deductible Expense in an Accounting

Human Care Canada Inc v Evolution Technologies Inc 2018 FC 1302 supplementary reasons 2018 FC 1304 Elliott J
            2,492,392

In Human Care v Evolution Tech, Human Care brought an action against Evolution for infringement of its 392 patent related to “rollators” – a “walker” with wheels, primarily used to assist the elderly with mobility issues. Evolution counterclaimed that the 392 patent was invalid. The case turned on the facts. One legal point of passing interest, the deductibility of legal costs as an expense in an accounting of profits, was raised.

Infringement, as usual, turned on claim construction, and Elliott J generally preferred the evidence of Human Care’s expert. For example, Elliott J agreed with counsel for Human Care that the key expert for Evolution “has looked at the claims, picked at random words, define[d] them outside of the claims, and then reinserted them into the claims” [189]. Validity attacks based on anticipation [382], obviousness [405], [410], and overbreadth [420], likewise failed on the facts.

Turning to damages, the parties agreed that the quantum for reasonable compensation for ‘infringement’ after publication but prior to grant, should be based on royalties actually charged by Human Care during that period, and the number of units was also agreed [41], so there was “nothing to discuss” on this issue [432].

Elliott J held Human Care was entitled to elect an accounting rather than damages, essentially on the basis that there was no reason, such as undue delay, for denying the election [436]. This is consistent with the general practice of presumptively allowing the patentee to elect an accounting unless there is some equitable reason to refuse it. (There are one or two cases where the Court has held that the burden was on the successful patentee to establish an entitlement to an infringement, but these are the exception.)

It appears that Human Care’s rollator design swept the market, so that there was no non-infringing alternative; if Evolution had not sold infringing rollators, it would have had to leave the market, and might well have gone out of business [455]. Elliott J noted that “Where there is no non-infringing alternative, the infringer must turn over all profits made from the infringing act, less legitimate expenses incurred” [462].

One unusual point is that Evolution sought a deduction for legal fees as a business expense. Elliott J noted that:

[477] This Court has been generally hesitant to accept deductions for legal fees. For instance, in Teledyne [(1982), 68 CPR(2d) 204), Mr. Justice Addy at [pages] 214-216 did not allow the defendant to deduct legal expenses because it was concluded that such an approach would allow the infringing party to retain part of its unjust enrichment.

The point was apparently a novel one in Teledyne, as the only cases cited related to deductibility for income tax purposes of legal expenses incurred for the purpose of doing business, and as such, “are not remotely applicable” (215). To say Addy J was "hesitant" to accept such a deduction, is an understatement. He said (my emphasis):

That question must be answered most emphatically in the negative, regardless of the fact that the expenditure might well be considered from a general accounting standpoint as being a variable expense incurred in the course of selling the infringing product. Allowing this deduction would amount to the Court rewarding the wrongdoer and contravening its own finding. Such a decision would, in my mind, be likely to bring the administration of justice into disrepute and, in addition, contribute to the unjust enrichment of the wrongdoer. It is impossible for me to conceive how a court of equity would even seriously consider these expenses as a legitimate deduction and indeed the Defendant was unable to point to any case where the question was even raised.

I admit the concept does seem outrageous, but outrage is always an uncertain basis for a legal holding, and to my mind Addy J’s next point was more persuasive:

Furthermore, the Court in this action awarded-costs to the Plaintiff on a party-and-party basis. A deduction of the Defendant's costs on a solicitor-and-silent basis would in effect constitute a direct contradiction of its previous order. Costs in an action have always been considered separately from the ether claims of the parties to that action, as the considerations governing allowance or disallowance of costs, the amounts granted and the scales on which they are to be calculated are quite different from those which govern the Court's findings on substantive issues. It is for this same reason that a successful plaintiff, who elects to as for an assessment of damages, is not entitled to add his legal expenses in prosecuting the action as part of the damages incurred.

That strikes me as entirely persuasive. Costs awards are dealt with separately, with distinct considerations, related to eg the incentive to litigate, and the need to sanction the conduct of the case, and so on. To allow deduction of the legal fees as an expense on the accounting would undermine the rationale for the costs award.

(Note that Addy J remarked that “[a] similar claim was also disallowed in the Dubiner v. Cheerio Toys case [[1966] Ex.C.R. 801, 837-38]” but I note that in Dubiner the legal costs were disallowed primarily “on the simple ground that the defendant failed to prove these accounts,” and it is therefore not strong authority for refusing the deduction as a matter of principle.)

In the case at hand, Elliott J, after citing Teledyne, nonetheless allowed a deduction for legal costs to a certain extent, as being the amount the defendant “spent prior to the litigation in this and a parallel dispute” [478]. This seems to suggest that the principle enunciated by Addy J is applicable only in respect of litigation expenses incurred after the statement of claim is actually filed. I’m not sure that is a principled distinction, but the issue discussed so briefly that I won't explore it further..

Overall, a number of the expense deductions were disallowed in whole or in part for lack of adequate proof. The result was a “rough justice” award of just over $12 million.

Elliott J also granted a permanent injunction on established view that ““[t]he Court should refuse to grant a permanent injunction where there is a finding of infringement, only in very rare circumstances” [485], quoting Valence v Phostech 2011 FC 174 [240]. Compound interest (“profits-on-profits”) was refused on the basis that Human Care “did not provide thorough submissions on why profits-on-profits is merited in this case” [487]. The supplementary reasons clarified the terms of the injunction and order for delivery up, as well as the details of the damages and interest assessment.