Monday, October 19, 2020

Non-Infringing Baseline as an Alternative to “But For” Causation

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

In an accounting of profits the infringer is required to disgorge its profits caused by the infringement. In the standard approach causation is determined using the “but for” test, in which the amount the infringer actually earned by using the infringing technology is compared with what the infringer would have earned in the hypothetical “but for” world in which it used the best non-infringing option: Schmeiser 2004 SCC 34 [102]. As explained in last week’s post, Stratas JA’s decision for the majority in Nova v Dow rejected “but for” causation in the context of an accounting of profits. He proposed instead to assess the profit to be disgorged by comparing the infringer’s actual profit against a non-infringing “baseline,” which, in his view, better reveals the value added by the invention itself [62], which is to say the value associated with the “inventive quality” of the patented technology [78]:

[73] Non-infringing alternatives are used not to determine what the infringer could have done instead of infringing (i.e., “but for” reasoning), but instead to establish a non-infringing baseline to isolate the value of the patent.

Stratas JA did not provide an explicit definition of the non-infringing baseline, but rather illustrated its nature with one or two examples. While I appreciate the intuition underlying Stratas JA’s examples, the rule under established law is that the infringer must disgorge the profits caused by the infringement, not the profits associated with the inventive quality of the patented technology. The established “but for” test isolates the profits caused by the infringement and in my view this is sound as a matter of policy.

Stratas JA emphasized the need for a causal nexus throughout his decision, but he made the point in a couple of subtly different ways. In many places he emphasized the need for “a causal connection between the profits to be disgorged and the patent infringement” [46]; and see similarly [27], [32]. In other places he stated that the disgorgement of profit “must focus on the value added by the invention itself” [62]; and see similarly [61] (“causally attributable to the value of the patent”), [78] (quoted below). I’ll argue that there is a difference between these two ways of framing the causation requirement, and that the first is correct while the second is not.

First we need to understand what Statas JA meant by the “value added by the invention itself.” He gave a couple of examples to illustrate what he meant:

[64] What is the value of a patented pain reliever that provides eight hours and one minute of pain relief when there is a non-infringing alternative that provides eight hours of relief? The patentee did not invent pain relievers; the patentee only invented a drug that added an extra minute of relief.

In this example, the pain reliever that provides eight hours of relief is the “baseline” against which the value of the patented pain reliever is to be assessed. To the extent that the eight hour pain reliever is readily available on the market, “but for” causation and the non-infringing baseline give the same result. But for the infringement, the infringer would have used the eight hour pain reliever, and the benefit from the patent is the extra one minute of pain relief, which is also identified by Stratas JA as the value of the patent. Stratas JA’s suggestion at [73] that non-infringing alternatives have really been used to establish a non-infringing baseline seems to be saying that in many cases, such as the pain-reliever example, “but for” reasoning does end up with the correct “baseline” comparator.

However, the “but for” approach and the baseline approach do not always converge. This is illustrated by Stratas JA’s more important example, that of Rivett FC 2009 FC 317 aff’d Rivett FCA 2010 FCA 207, in which the court used as a comparator a non-infringing alternative that was not in fact available to the infringer at the time of the infringement:

[77] The Federal Court’s decision in Rivett FC, affirmed by this Court, best illustrates why “baseline”, not “alternative”, is more appropriate terminology in the accounting of profits context. In Rivett FC, the Federal Court used a non-infringing alternative even though the “alternative”—in that case, regular, unpatented [soybean] seed—was not locally available to the infringer during the infringement period. Using “but for” logic, the Federal Court could not consider the non-infringing alternative because the infringer had no access to the non-infringing seeds: but for the infringement, the infringer would still have used the patentee’s seed.

[78] But the Federal Court resisted the “but for” reasoning and used the regular soybean seed as an alternative even though the infringer could not have used it. If non-infringing alternatives must be true “alternatives”, “the fact that the [product] has a value apart from the invention will be ignored”: Rivett FC at para. 62. The patent is not valuable because it just so happens to be unavailable in a particular locale. It is valuable because it has some inventive quality that increases the infringing product’s profitability or marketability. For the Federal Court in Rivett, the point of using non-infringing alternatives was to isolate the value of the patent. It was irrelevant whether the infringer could have—in a hypothetical universe—avoided the infringement because it had an alternative course of action. This point was affirmed on appeal: Rivett FCA at paras. 50-57.

In Stratas JA’s view, we have to choose a comparator that isolates the value of the invention that is due to its inventive quality, and not a value that reflects the vagaries of the distribution system. This implies that the correct comparator is conventional soybean, even if it is not actually available. The use of “but for” would lead to—well, it’s not clear from this example exactly where it would lead, but it would definitely lead somewhere else, given that conventional soybean seed was not locally available. Since conventional soybean is the correct comparator and “but for” reasoning would not use conventional soybean as the comparator, “but for” reasoning must be rejected. Instead we have to use a non-infringing “baseline”—in this case conventional soybean—which strips out those irrelevant factors.

This seems intuitively reasonable, and Stratas JA is right to say that under the “but for” approach the happenstance of the local availability of conventional soybean would affect the amount to be disgorged, even though it is unrelated to the inventive quality of the invention. But exactly the same problem arises even if conventional soybean is actually available.

Let’s take a deeper dive into the Rivett example, in which, as Stratas JA noted, the calculation used by Zinn J at trial and approved by the FCA proceeded as if conventional soybean had actually been available. In Rivett the evidence accepted by the trial judge established that the profit from patented soybean would typically be $265 and the profit from conventional soybean would typically be $217, for a typical differential of $48 [Rivett FC 100]. This profit differential is partly due to the higher yield and lower herbicide cost of patented soybean (which increases the differential), and partly to the higher cost of patented seed (which decreases the differential). While $48 is the typical differential, Rivett did not buy his seed, but inherited it from his father at no cost [Rivett FC 101]. Since the price of patented seed was $51, the profit differential for Rivett between using patented seed which he inherited and the comparator of buying conventional seed, was $99. This was the basis for the calculating the amount to be disgorged.*

Thus, in Rivett itself the amount to be disgorged reflected in part the advantages of the patented invention (higher yield, lower herbicide use) and partly the happenstance that Rivett inherited the patented soybean seed from his father. If Rivett had grown the patented seed himself (perhaps from seed retained, in breach of the licence, from a prior crop of licensed seed, or from adventitious seed that had blown onto his property harvest), the cost of growing and harvesting the soybeans that were used to seed the crop that was ultimately sold would have been an actual cost of infringement that would be deducted from his actual profits, thus reducing the differential. Whether Rivett grew the seeds himself or inherited them from his father does not affect “the inventive quality that increases the infringing product’s profitability or marketability,” but it nonetheless affects the amount to be disgorged under the approach actually used in Rivett, and presumably also under Stratas JA’s baseline approach, given that he provided Rivett as an example.

Further, in Rivett there is no way to tell the value of the inventive quality of the invention. Part of the profit differential is due to the cost of the patented seed, which was $51 as compared with $18 for conventional seed [Rivett FC 100]. Presumably the cost of locally purchasing conventional seed includes some amount paid to the seed grower (let’s suppose that’s $10) and some amount to intermediaries, such as the local distributor, for shipping, handling and distribution ($8). Suppose the cost of growing and distributing patented seed is the same as for conventional seed. This means that $33 of the cost of patented seed is a royalty to the patentee. That would suggest that the value of the inventive quality that increases the infringing product’s profitability or marketability would be $81. (When a farmer buys licenced seed, that value is split between the parties with $33 going to the patentee and $48 going to the licensee.) It seems intuitive to say that this $81 difference in profitability of patented soybeans as compared with conventional soybeans is attributable to the inventive quality of the patented technology.

However, to conclude that the value of the invention is $81, I had to suppose that seed growing and distribution costs are the same for patented seed and conventional seed. That is plausible, but by no means certain. It is a matter for evidence, and there was no evidence at all on that point in Rivett.

The growing and distribution costs might very well be different for patented and conventional soybean. Suppose that when the patented soybean was first introduced conventional soybean was still much more popular, so that while both were locally available from the same distributor, the distributor ordered conventional soybean in much larger quantities with consequent lower freight and handling costs. While the distribution cost for conventional soybean was $8, the distribution cost for patented soybean was $12, so that only $29 of the $51 cost of patented bean was a royalty to the patentee. This implies that the value of the inventive quality that increases the infringing product’s profitability or marketability would be $77, not $81. Without delving into the details of the seed cost, which the court in Rivett did not do, we have no way of knowing whether this is true, which is to say we have no way of knowing the value attributable to the inventive quality of the patented seed.

So, even if conventional soybean is actually available and used as a comparator, this does not mean that the profit to be disgorged reflects solely the inventive quality of the patented technology. Indeed, in Rivett, it also reflected the happenstance that Rivett inherited his seed. Consequently, if the goal were to ensure that the amount to be disgorged reflected only the differences attributable to the inventive quality of the patented technology, it would be necessary to dig into the details of the pricing, to separate out the part that is due to differential distribution costs. (And this is not to mention the difficulties involved when revenues are also different.)

This would involve formidable conceptual difficulties. Suppose that conventional soybean seed is not locally available, but is available on a special order at a higher price. It would seem that on Stratas JA’s view this higher shipping cost should not be relevant, as being unrelated to the inventive quality of the patented technology. But what if the reason that conventional soybean seed is not locally available is that patented soybeans are so much more profitable that there is no demand for conventional soybeans. In that case, is the lower distribution cost attributable to the inventive quality of the patented seed? Suppose patented soybean seed is more expensive because of government regulations requiring a buffer zone around the fields of seed soybeans in order to avoid contamination of surrounding fields. Would the extra cost of compliance with those regulations be considered to reduce the value of the inventive quality of the invention?

The practical difficulties are perhaps even more formidable. Even backing out distribution costs would be difficult, as it would require a forensic accounting analysis of at least one, and perhaps several non-parties. And while I’ve been focusing on distribution costs in light of the Rivett example, there are myriad other costs which are arguably unrelated to the inventive quality of the invention. The patentee might put more effort into marketing patented seed, which would be partially reflected in the seed price; the patentee might grow at fewer (or more) locations than convention seed growers, with different distribution costs; the patentee’s growers might be more (or less) efficient than growers of conventional seed, and so on.

So, Stratas JA’s view that using conventional soybean as a comparator isolates the value attributable to the inventive quality of the patented technology implicitly assumes that all other costs are comparable. There is no reason to believe that this is generally true and backing out all this information would be very difficult. Moreover, in practice it is not done. This makes it difficult to accept Stratas JA’s suggestion that the standard non-infringing alternative analysis really involves selecting a non-infringing baseline to assess the value attributable to the inventive quality of the patented technology. As discussed, the quantum awarded in Rivett did not reflect solely the inventive quality of the patented technology. An attempt to isolate the value attributable to the inventive quality of the patented technology would look very different from what we actually see in the cases.

To recap, Stratas JA correctly pointed out that “but for” causation does not isolate the value of the patented technology, but also reflects considerations such as the happenstance of the local availability of conventional soybean seed. This problem lead him to reject “but for” causation in favour a non-infringing baseline. To this point I’ve argued that exactly the same problem arises under his baseline approach.

Further, this putative problem is not really a problem at all. No one knows the value contributed by the inventive quality of the patented technology and it does not matter. The rationale for the patent system is that it provides an incentive to invent. That incentive is provided by the private return to the patentee from exploiting the invention. In a world without any infringement, that private return is determined by the advantage that the patentee is able to extract in real-world competition with various rivals using non-infringing technology. The advantage of the patented technology over the non-infringing options does not turn solely on whatever value we might decide is attributable to the inventive quality of the technology; it turns on the actual difference in profitability, which in turn does depend on things like distribution advantages, including the practical availability or otherwise of the putative alternatives, as well as all the other elements that go into making a real product and bringing it to market.

As importantly, “but for” causation puts the infringer in the position it would have been in had it not infringed. As Stratas JA stressed, his baseline approach “ is indifferent to whether an infringer will be ‘better off’ or ‘worse off’” [153]. This means that the baseline approach may drive a wedge between the amount that the infringer would make by competing without infringing, and the amount it would have to disgorge from infringing. This will distort the operation of the patent system. If the infringer would have to disgorge less than the amount it would have made in non-infringing competition, then it would have an incentive to infringe. If it had to disgorge more, this would effectively expand the scope of the monopoly beyond its proper limits, because of the chilling effect on legitimate competition resulting from uncertainty as to patent scope and validity.

I’ll note that there are a variety of reasons, in addition to those identified by Stratas JA, why the patent exclusivity does not allow the patentee to capture the true value of the invention. Consequently, some commentators have argued that patent remedies should be adjusted to reflect the true social value of the invention: see Shavell & van Ypersele, “Rewards Versus Intellectual Property Rights,” (2001) 44 J Law & Econ 525; Sichelman, “Purging Patent Law of ‘Private Law’ Remedies,” (2014) 92 Tex L Rev 517. These suggestions have not been generally accepted, even among academics, for the reasons just discussed: see Siebrasse, Holdup, Holdout, and Royalty Stacking: A Review of the Literature, in Biddle et al (eds), Patent Remedies and Complex Products: Towards a Global Consensus (Cambridge University Press, 2019), Ch 7at 249-51.

In my view, the true principle was stated by Stratas JA when he said “ An accounting of profits is directed to the disgorgement of benefits obtained by infringers as a result of the infringement, no more, no less” [27]; and similarly [32]. The benefit as a result of the infringement is typically not the value attributable to the inventive quality of the patented technology; it is the difference between what the infringer in fact made and what it would have made in the “but for” world in which it used the best non-infringing option.

I’ll conclude with a few words about Rivett itself. As Stratas JA pointed out [78], the FCA in Rivett endorsed the use of conventional soybeans as a comparator even though they were not available to the infringer at planting time. However, the question facing the court in Rivett was whether to use conventional soybean as a comparator, or to require Rivett to disgorge the entire actual profit, without any allowance for a non-infringing alternative: see Rivett FC [58]. Given those choices, the use of conventional soybean is clearly correct. Rivett does not foreclose a strictly factual “but for” inquiry, for example involving use of another crop, which was not at issue in the decision. Stratas JA stated that in Rivett “It was irrelevant whether the infringer could have—in a hypothetical universe—avoided the infringement because it had an alternative course of action.” That is Stratas JA’s gloss on Rivett, but there is no holding in Rivett itself to that effect, as neither level of court was faced with the question of whether Rivett could have avoided infringement with an alternative course of action. For the same reason, with respect, I do not think it is accurate to say that the Federal Court “resisted” the “but for” reasoning, as Stratas JA suggested at [78]; there was nothing to resist, as “but for” reasoning was simply not on the table.

*This glosses over some details. The unit of measure of the profit differential was not given; presumably it was per acre or per hectare or per 50lb bag of seed, or something along those lines. The exact unit was not essential to the calculation, as Zinn J in Rivett FC [101]-[102] worked in percentages. He noted that Rivett would have made 69% of his actual profit had he used conventional seed, so conversely, 31% of his actual profit was due to the infringement. The quantum to be disgorged, $40,138, was therefore calculated as 31% of the actual profit of $129,477.21.

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