Monday, October 26, 2020

Deduction of Fixed Costs in Nova v Dow

 Nova Chemicals Corporation v Dow Chemicals Company 2020 FCA 141 Stratas JA: Near JA / Woods JJA dissenting, aff’g 2017 FC 350, 2017 FC 637 Fothergill J

            2,160,705 / film-grade polymers / ELITE SURPASS

As explained in my first post, Stratas JA’s decision for the majority in Nova v Dow departed from established law by rejecting “but for” causation in the context of an accounting of profits in favour of using a non-infringing “baseline” to assess the amount to be disgorged. Subsequent posts have discussed various conceptual issues: see here and here. This post turns to the specific question of deductibility of fixed costs. This question is important in practice—deduction of fixed costs can have a substantial impact on quantum—it is conceptually difficult, and the case law is unsettled. Stratas JA’s decision would always allow an infringer to deduct some portion of fixed costs, regardless of whether the infringer had another opportunity that it would otherwise have pursued [162]. This is a bold holding, which departs from prior Canadian practice and is in contrast with the UK and Australian law. Unfortunately, Stratas JA’s holding on fixed costs is based on his unorthodox approach to causation, and consequently, as I will suggest in this post, it is unsound in principle.

It’s not clear to me how trial courts and litigants will deal with this issue going forward. On the one hand, the majority in Nova v Dow held that a proportion of fixed costs are always deductible, but on the other hand this holding is based a rejection of “but for” causation in the context of an accounting and is therefore, in my view, inconsistent with the SCC authority in Schmeiser 2004 SCC 34. Now, in many cases, deduction of a portion of fixed costs is permitted by Schmeiser, so it may be some time before a case arises in which the two approaches diverge. When such a case does arise, I would guess that the FC judge will do the calculation both ways, pick one, and then let the FCA sort it out on appeal. Perhaps that day will come sooner rather than later, as the uncertainty created by Nova v Dow will make it more likely that an accounting of profits dispute will go to trial rather than settling.

In the liability phase of this action, 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, and Dow elected an accounting: 2017 FC 350 [106]-[107]. One question that arose is whether Nova should be entitled to deduct some portion of its fixed costs. There is no question that incremental costs associated with the infringing product, such as the cost of raw materials, may be deducted [155]. There is a debate as to deductibility of fixed or common costs, such as capital depreciation and plant overhead costs, and general marketing and administrative costs, which remain constant whether or not the infringing product is made. (See here, here and here for prior posts.) The cost of lighting the plant is a simple example, as the lights have to remain on and would consume the same amount of electricity, whether or not the infringing product is made.

Three approaches to fixed costs

There are three general approaches: never allow deduction of fixed costs; always allow deduction of some portion of the fixed costs; allow deduction of some portion of the fixed costs in some circumstances.

The argument for never allowing fixed costs is that they are not caused by the infringement and so allowing deduction would put the infringer in a better position that if it had not infringed. On this view, we should look only to incremental costs and revenues that are associated with the infringement. As Example 1, suppose the defendant’s plant is operating below capacity making non-infringing goods, with incremental (raw material) costs of $800, revenues of $1000 and a lighting bill of $100, for an overall plant profit of $100. It then starts making infringing goods as well, which generate revenues of $500 with a raw material cost of $200. Since it was operating below capacity, it also continues to make the same non-infringing goods. The lighting bill does not change. This results in a total plant profit of $400. If only the incremental costs of the infringing product are deducted from the revenues from the infringing product, then the infringer will be required to disgorge $300, returning it to an overall plant profit of $100—the same as if it had not infringed. It seems intuitive that the lighting cost was not caused by the infringement, as it was being incurred before the infringement ever started; and if some proportion of lighting cost is deducted from the infringing revenues—say 35%, proportionately to revenue from infringing goods—then the infringer will only be required to disgorge $265. Its overall profit, after paying this award, will be $135, and so the infringer will be better off than if it had not infringed.

The general argument for always allowing deduction of some portion of fixed costs is that fixed costs are nonetheless actual costs of production; the plant cannot make infringing products if the lights are turned off and a business that does not cover its fixed costs will not be profitable: see [158]. For Example 2, suppose the plant only makes an infringing product which brings in revenues of $1000. The incremental cost for the infringing product is $800 and the lighting cost is $100, for a total plant profit of $100. If the infringer cannot deduct fixed costs, it will be required to disgorge $200, giving a negative overall ‘profit’ of $100.

A middle road allows deduction of some fixed costs in some circumstances. There are three variants that are more or less closely related.

One way of approaching the problem is to simply apply the differential profit approach, based on “but for” causation, from Schmeiser 2004 SCC 34 [102]: “A comparison is to be made between the defendant’s profit attributable to the invention and his profit had he used the best non-infringing option.” With the differential profit approach, the problem largely disappears, as the deductibility of fixed costs is reflected in the question of what the infringer would have done but for the infringement.

So, in Example 1, the plant was operating below capacity prior to making the infringing product. This implies that but for the infringement, it would have simply continued making the same non-infringing goods it had always made, giving a “but for” profit of $100. The actual profit is $400, which gives a differential profit of $300.

This gives the same result as not deducting fixed costs at all, so what about Example 2, given as a counter-example to the first? Example 2 neglects the crucial question of what the infringer would have done but for the infringement. There are a few possibilities.

Suppose 2(a) the infringer only made infringing goods because the plant was good for nothing else, so that but for the infringement the plant would have sat idle. If the lights have to stay on, perhaps because of safety regulations, then the ‘profit’ but for the infringement would be negative $100. In that scenario, refusing to allow a deduction for fixed costs, thus requiring disgorgement of $200, would put the infringer in the position it would have been in but for the infringement. Alternatively, suppose 2(b) the infringer could turn the lights off if the plant was not producing anything. In that case, the profit in the “but for” world would be 0, and, using the differential profit approach, the infringer would be required to disgorge only $100. Perhaps the most likely variant 2(c), is that but for the infringement, the lights would stay on and the infringer would have produced a less profitable non-infringing product, with, eg total revenues of $1000, incremental costs of $850 and the same $100 lighting costs. In that case the differential profit would be $50.

What about the argument that fixed costs are actual costs of production and so must be deducted? In the differential profits approach, they are deducted—in both the actual and “but for” worlds. More precisely, it doesn’t matter whether we deduct fixed costs or not, so long as we are consistent, because if they are truly fixed, they will be the same in both the actual world and the “but for” world— as in Examples 1 and 2(a),(c)—and we will get the same result either way. (As a practical matter, it is easier to ignore them.) But the differential profit approach does not actually ignore common costs, as is shown by Example 2(b) where the common costs are not truly fixed.

Another middle ground approach is to reframe the problem as involving deduction of opportunity costs. On this approach, like the incremental cost approach, fixed costs are not considered to be caused by the infringement. However, in order to make infringing product, the defendant may have foregone the opportunity of making some other non-infringing product, and if both products cannot be made at the same time, perhaps due to plant capacity limitations, then the loss of that opportunity is caused by the infringement. The opportunity cost is the value of the opportunity that was foregone in order to produce the infringing product. On that approach, the amount that the infringer would have made but for the infringement— the lost opportunity, if there was one — is conceived of as an actual cost, and so the opportunity cost is added to incremental costs to arrive at total costs, which are then deducted from the actual revenue to get the profit. (Fixed costs are ignored throughout, on the view that they are not caused by the infringement.)

The opportunity cost approach is closely related to the differential profit approach, and will typically give the same result as the differential profit approach, because the opportunity cost is the same as the “but for” profit (if the fixed costs are truly fixed). As discussed in last week’s post, the opportunity cost approach differs conceptually from the differential profit approach in conceiving of the foregone opportunity as an actual cost that is deducted from actual revenues to arrive at actual profits in the first stage of the Schmeiser test, while in the differential profit approach the foregone opportunity is considered in the second stage of the test, as a profit that would have been made but for the infringement. As also discussed in last week’s post, in my view framing the issue in terms of opportunity costs simply muddies the waters to no particular benefit. The differential profits approach from Schmeiser can be applied perfectly well without any reference to opportunity costs.

The third middle ground is the approach taken by the High Court of Australia in Dart Industries [1993] HCA 54:

[15] Where the defendant has forgone the opportunity to manufacture and sell alternative products it will ordinarily be appropriate to attribute to the infringing product a proportion of those general overheads which would have sustained the opportunity. On the other hand, if no opportunity was forgone, and the overheads involved were costs which would have been incurred in any event, then it would not be appropriate to attribute the overheads to the infringing product.

That is, a portion of fixed costs may be deducted, but only if the infringer can establish that it would have used the plant capacity in some other way but for the infringement. This is similar to allowing deductibility of opportunity costs in that a foregone opportunity must be established and if so, the associated fixed costs are deducted as an actual cost along with incremental costs. It differs from the opportunity cost approach and also from the “but for” approach, in that it does not allow anything for the foregone profits as such: see here for a brief discussion. Dart Industries has been quite influential, particularly in the UK: see Hollister [2012] EWCA Civ 1419 [80]-[85], discussing Dart Industries and finding the reasoning “persuasive”; and see OOO Abbott v Design & Display Ltd [2016] EWCA Civ 95, [38]-[42]; and it was also the approach used by Fothergill J at first instance in the case at hand.

In my view, the differential profit approach is sound in principle (see here), and it has the additional benefit of being supported by the authority of Schmeiser. However, it is never used to address fixed costs. Why not? Descriptively, the answer lies in the history of the development of the law. The problem of fixed costs arises even under the old rule requiring disgorgement of actual profits, where the question is whether fixed costs are deductible from actual revenues to arrive at actual profits. That is a sensible way to look at the problem, given that fixed costs are indeed actual costs. Both the opportunity cost approach and the Dart Industries approach can be applied in an actual costs approach and were developed in that context. But this means that the problem had been addressed in the case law well before Schmeiser, and even after Schmeiser it seemed natural to continue thinking of the problem as involving deductibility of actual costs.

This suggests we should address deductibility of fixed costs simply by a thoroughgoing application of the differential profit approach. While this may well be best solution to the problem, there is one further wrinkle. The Dart Industries approach might also be defended on grounds of administrative convenience. As noted, the opportunity cost approach will normally give the same result as the differential profit approach, and the Dart Industries approach will give a similar result, though not normally the same result. If the Dart Industries approach is administratively simpler, it might be justified as a rough proxy for the application of the differential profit approach. Put another way, even though, in my view, the differential profit approach is the best approach to fixed costs in principle, it is possible that the Dart Industries approach is the best approach in practice: this was more or less the position of McHugh J in Dart Industries at [13]ff. My inclination is to think that strict application of the differential profit approach is indeed the best way to go, but that turns on the details of how the test is applied in practice and is beyond the scope of this blog post.

The Canadian case law is unsettled. The leading case is Addy J’s decision in Teledyne (1982), 68 CPR(2d) 204 (FC) which refused to allow deduction of fixed costs. Teledyne has been interpreted as holding that fixed costs are never deductible in an accounting, but there was no finding that there had been a forgone opportunity, and consequently Addy J’s refusal to deduct fixed costs is consistent on the facts with both the Dart Industries approach and the differential profit approach from Schmeiser: see Siebrasse et al Accounting of Profits in Intellectual Property Cases in Canada, 24 CIPR 83 at 103.

Nova v Dow

With this overview, we can turn to the decision of Stratas JA in Nova v Dow, which discusses fixed costs at [143]-[164]. At first instance, Fothergill J applied Dart Industries to allow a proportional deduction of various fixed costs in light of his finding of fact that but for the infringement Nova would have used the same plant capacity to produce non-infringing products [FC 158], [FC 165]. Stratas JA affirmed, but not on the basis of Dart Industries, which he specifically rejected [146]. Instead, Stratas JA held that “Any infringer, regardless of whether it is operating at full capacity, should be able to deduct a proportion of its fixed costs” [162]; and similarly [145] (“the ‘full costs’ approach should always be available to an infringer”). I’ll proceed in the same order as Stratas JA, by first considering his critique of Dart Industries, and then turning to his justification for always allowing deduction of fixed costs.

Critique of Dart Industries

Stratas JA's initial objection to Dart Industries was that it “allows an infringer to deduct a hypothetical opportunity cost which is not a cost actually incurred” [148]. This is not quite right; Dart Industries allows deduction of some fixed costs, which are costs that were actually incurred, but only when there was a foregone opportunity. This comment is perhaps better regarded as a critique of the related opportunity cost approach. As discussed here, the opportunity cost approach departs from the differential profit approach in considering the foregone opportunity at the first stage of the Schmeiser test instead of at the second stage.

But Stratas JA’s critique goes beyond this: “accounting of profits occurs in the real world. Actual profits must be disgorged which means only actual costs can be deducted” [148]. This criticism reflects Stratas JA’s wholesale rejection of “but for” causation and the Schmeiser test, discussed here, and it is applicable to Dart Industries, as well as the other middle ground approaches, including the differential profit approach and the opportunity cost approach. As discussed in my previous posts, I am of the view that the Schmeiser test is sound in law and policy, and I therefore consider this critique to be entirely misplaced.

As noted, Dart Industries does not permit deduction of opportunity costs as such, but rather allows deduction of a portion of fixed costs if an opportunity has been foregone. As Stratas JA notes at [150], if deduction for both opportunity costs and fixed costs were denied, “the defendant would be in a worse position than if it had made no use of the patented invention.” Stratas JA criticized this on the basis that “Whether the infringer would be better off or worse off but for the infringement is irrelevant. The reality is that the infringer did infringe and, therefore, it must account only for its actual revenue and deduct only its actual costs” [151]: and similarly [153]. Again, as previously discussed, this is based on a rejection of “but for” causation and the Schmeiser test, and consequently I consider this critique also to be misplaced.

Stratas JA then noted that “If the infringer can deduct opportunity costs to off-set or absorb its fixed costs, why should it not be able to deduct all of its opportunity costs? Why draw the line at fixed costs? If the court does not want the infringer to be ‘worse off’, it would allow the defendant to deduct all of its opportunity costs” [152]. This is a very good question, but Stratas JA poses it rhetorically, on the view that it is clear that opportunity costs should not be deducted. As discussed above, I consider this to be a live issue. Arguably opportunity costs should be generally deductible—more precisely, the differential profits approach should be applied to include all costs. Stratas JA also noted that “Dart Industries carves out a limited use for opportunity costs to reduce a ‘real inequity’ but this exception is not rooted in any principle” [154]. I agree that the Dart Industries approach is not directly rooted in principle, but as discussed above, it might be defended on the basis that it broadly reflects the differential profit approach and departs from it only for practical reasons.

Stratas JA did not directly consider the differential profit approach to fixed costs. As noted, whatever the theoretical merits, the differential profit approach had not been explicitly applied to deal with fixed costs and presumably it was not argued. It is nonetheless clear enough that Stratas JA would reject the differential profit approach, given that the differential profit approach is directly based on “but for” causation, and Stratas JA is of the view that “but for” causation is not applicable to an accounting of profit.

Deduction of Fixed Costs

We may now turn to considering Stratas JA’s holding that a portion of fixed costs should always be deductible. As noted above, the main argument against this position is that it may put the infringer in a better position that it would have been in but for the wrong, as in our first example where the infringer was operating below capacity. This argument carries no weight with Stratas JA, who, as we have seen, simply rejects “but for” causation in the context of an accounting. Nonetheless, given that “but for” causation is otherwise very well established, and, in my view, sound in policy, I consider this a good prima facie argument against Stratas JA’s position. The question then is what rationale he provides which justifies a departure from the standard approach to causation.

Stratas JA’s argument in favour of always allowing deduction of fixed costs turns essentially on the view that fixed costs are actual costs that are necessary to produce the infringing goods: [157]. This is true enough, but as Stratas JA emphasized, it is uncontroversial that an accounting requires disgorgement of all profits caused by the infringement: [27], [32], [46], [61], [62], [80]; and see Schmeiser [101]; Perindopril 2017 FCA 23 [28]. The question then, is what approach to causation was being used by Stratas JA to justify always deducting a portion of fixed costs, given that such a deduction cannot be justified by “but for” causation, which Stratas JA in any event rejected.

While Stratas JA was evidently of the view that some portion of the fixed costs are indeed caused by the infringement, he did not provide any express statement of the causation principle that he was invoking. The most prominent alternative to “but for” causation is “material contribution,” but this approach is disfavoured and may be used only in special circumstances: Clements v Clements 2012 SCC 32. Stratas JA did not expressly base his analysis on the “material contribution” test, nor did he consider the restricted circumstances in which it may be applied, so it seems clear enough that he wasn’t relying on a material contribution approach. Stratas JA applied a non-infringing “baseline” approach to other aspects of the accounting, but he did not apply it to the fixed costs issue and it is not clear to me how it could be applied. Thus it is not clear what concept of causation is being invoked by Stratas JA.

Instead, his argument rests on some intuitions about causation, bolstered by some examples:

[157] The reality is that the infringer did incur those costs. Without incurring certain overhead costs (e.g., property taxes, lighting, heating), the infringing product could not be produced.

The general point that Stratas JA is making is that fixed costs are actual costs of production just as much as incremental costs; you need raw materials to make a product, but you also have to have the lights on. It is artificial to allow deduction of one but not the other. The difficulty with this argument is that it reverses the causation analysis. Yes, it is necessary to incur the fixed costs in order to produce the infringing goods; even though the infringing goods would not have been produced without turning on the lights, the question is whether the lights would have been on if the infringing goods had not been produced. The question is not whether the costs caused the infringement, but whether the infringement caused the costs.

Stratas JA then gave the following example:

[158] Consider a factory that produces eight separate infringing product lines where each product infringes a different patent. If each of the eight patentees brings separate infringement proceedings, could the infringer never deduct its overhead costs?

Stratas JA is evidently posing this question rhetorically, on the view that it is apparent both that the infringer should be able to deduct its overhead and that this would not be permitted under an alternative approach, such as the differential profit approach.

The answer is not so clear to me. This is like Example 2, except with eight small infringements instead of one big one. Stratas JA was evidently of the view that there is something unique about a situation with multiple infringing products and multiple patentees. If there is a non-infringing alternative, then I can’t see any difference in the analysis between one or multiple infringements; the short answer to Stratas JA’s question is that yes, the infringer can deduct its overhead costs. (For the longer answer, see the discussion of the differential profits approach, above.)

If there no non-infringing alternative, and costs are truly fixed—the lights must remain on whether or not the plant is operating at all, perhaps for safety reasons—then on the “but for” test, then the answer is that no, the infringer can never deduct its overhead costs; this is true whether there is one infringement, as in Example 2(a), or eight.

Perhaps Stratas JA had in mind a special case where there are no non-infringing alternatives, and but the overhead costs are not truly fixed—lights have to stay on as long as one product is being made, but can be turned off if no products are being made. That is like Example 2(b), except with eight separate infringements. From Example 2(b), we saw that if there is only one infringement, the infringer would be permitted to deduct its lighting costs using the “but for” test, for a total disgorgement of $100. It seems intuitive that it should not make any difference if there are eight separate small infringements instead of one big one. And indeed, we should in principle get the same result if there are eight infringing products, but there are procedural difficulties. Suppose that in example 2(b) there are eight separate products, with each generating revenues of $125 and raw material costs of $100. Each patentee sues separately and sequentially. During each action, we know that any of the eight products that was previously litigated is infringing, but there is no reason to believe that any of the other products are infringing. In the first action, in the most plausible “but for” world the lights would stay on in order to make the other products, and so the lighting costs would not be deductible. An accounting using “but for” causation would require the infringer to disgorge $25 to the first patentee. The same would be true in the second action, and so on, until we get to the eighth action brought by the eighth patentee. At this point we finally know there are no non-infringing alternatives at all. This means that fixed costs should be deductible—but whether or not we allow the infringer to deduct the $100 lighting costs in the eighth action, it will have already disgorged $175 to the other patentees and it can’t get that money back. That is, “but for” causation applied sequentially gives a different result from “but for” causation applied holistically. This is not due to any principle, but simply because the information has changed during the course of the litigation; it was always true in fact that all the products infringed a valid patent, but we did not know this until the final action.

This is not a difficulty in principle with but for causation, but rather a problem of coordination. This coordination problem may in some cases be addressed procedurally, by joinder or a trial of common issues, for example, though this is not always possible. Similar problems may arise in other contexts. For example, both direct and indirect purchasers may sue for private damages in respect of the same conspiracy under the Competition Act. The direct purchasers may recover for a loss that they did not actually suffer because they passed it on to indirect purchasers, who may also recover for the same loss. So both may sue in respect of the same loss, subject to an overarching rule against double recovery; see Pro-Sys 2013 SCC 57 [40] and Sun-Rype 2013 SCC 58 [21]. This means that which party actually recovers the loss will depend on who sues first, and on whether the actions are joined. As discussed here, a similar problem also arises where the infringement has an extra-territorial aspect, as where infringing goods are made in Canada and sold in the US, causing the patentee to lose US profits. In Canadian law, the patentee will be entitled to recover lost profits on the lost US sales, even though the infringer might be subject to a separate action based on the corresponding US patent, on the view that double recovery will be prevented by deducting amounts paid in the earlier action from the amount recoverable in a later action. In these scenarios, the Canadian courts have applied procedural approaches to the coordination problem rather than rejecting “but for” causation itself. I wouldn’t rule out an approach that rejects “but for” causation in a specific subset of cases to deal with these coordination problem: this was effectively the approach of the US Federal Circuit prior to the US Supreme Court decision in WesternGeco 138 S Ct 2129 (2018): see here and here for some commentary by Professor Cotter, who has an article in preparation on the topic. However, in the view of the Federal Circuit, the rejection of “but for” causation was driven by a tension with an important competing principle, namely the principle that patent rights are territorial. I see no such competing principle in the context of deduction of fixed costs. Consequently, while there may be difficulty in applying “but for” causation to fixed costs in the special case of multiple patentees suing sequentially when there are no non-infringing alternatives, I don’t see this as sufficient reason to reject “but for” causation.

Further, Stratas JA’s approach has its own coordination problems. In this example, under his approach 1/8 of the lighting costs ($12.50) would be deductible in each action, and the total disgorgement would be $100, as it would be under but for causation if there were only one infringing product. So, Stratas JA’s approach gives the better result in the scenario where all products are in fact infringing. But of course, we don’t know if all the products are actually infringing until the final action. If in fact the last product is not infringing, then Stratas JA’s approach would deduct too much, at least as compared with “but for” causation.

The next point made by Stratas JA was this:

[160] Denying the deduction of fixed costs generates a distorted picture of the infringer’s profits. It may be the case that an infringer has minimal variable costs but very high overhead costs such that the product is not, in fact, profitable. The incremental approach. . . could force that infringer to disgorge “profits” from an unprofitable product.

This brief remark is initially a bit confusing. If the infringer was unprofitable at making infringing goods, but would otherwise have been even more unprofitable, I don’t see any objection to forcing it to disgorge profits. I have an idea of another point that he may have been getting at, but it would require a lengthy digression, and I am not really sure it is what he had in mind in any event, so I will leave it to another post.

Allocation of fixed costs

Finally, Stratas JA stated the following:

[161] The fear that allowing a deduction of fixed costs would permit an infringer to, in effect, subsidize its non-infringing products is unfounded. An infringer would only be entitled to deduct a proportion of its fixed costs. For example, if an infringing product occupies 1% of a factory’s production capacity or volume, only 1% of the fixed costs will be deducted.

Presumably this “fear” was raised in argument, and I’m not entirely sure what it would have been. Perhaps it refers to the point that a deduction of fixed costs can put the infringer in a better position than it would have been in but for the infringement, as discussed in Example 1. If so, the fact that an infringer would only be entitled to deduct a portion of its fixed costs is not an answer to that concern; to the extent that the costs that are deducted would have been incurred in any event, the infringer is made better off that it would have been but for the infringement, as is illustrated by Example 1; whether 1% of 100% of fixed costs are deductible only affects how much better off. Of course, Stratas JA does not consider it relevant whether the infringer was made better or worse off, and so maybe this is not the concern he was addressing at all.

In any event, this passage raises a distinct problem with always allowing deduction of fixed costs, namely determining what proportion of the fixed costs should be deducted. Stratas JA addressed this question only tangentially, saying “An infringer would only be entitled to deduct a proportion of its fixed costs. For example, if an infringing product occupies 1% of a factory’s production capacity or volume, only 1% of the fixed costs will be deducted” [161]. I do not take this to be establishing a rule that the allocation is to be by “capacity or volume,” but only as an example. But it is not clear what principle is at play. Even in that example, it is not clear how production capacity or volume is to be measured. Suppose that a plant can make 1000kg/day of low margin pail and crate plastic, or 800kg/day of pail and crate plastic plus 10kg/day of highly profitable patented mLLDPE. Is the infringing product using 20% of the plant capacity (on the view that it displaces 20% of the pail and crate production), or 1.25%(by output weight)?

Further, there is no evident principle in using physical production capacity. Suppose the infringing product generates 35% of the revenue and 75% of the incremental profit, as in our first example, with only 1% of plant capacity. Should we allocate the fixed costs by capacity, revenue, or profit? Without any express principle of causation, it is difficult to know the basis for allocating fixed costs. This problem does not arise under the differential profit approach because fixed costs are not allocated between infringing and non-infringing products, but are accounted for in determining what would have happened but for the infringement.

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