Tuesday, September 26, 2023

What Causation Concept Is to Be Used in Allocating Fixed Costs?

GreenBlue Urban North America Inc v DeepRoot Green Infrastructure, LLC 2023 FCA 184 Gleason JA: Woods, Mactavish JJA varg 2021 FC 501 McDonald J

            2,552,348 / 2,829,599 / Integrated Tree Root and Storm Water System

DeepRoot’s 348 and 599 patents relate to a landscaping system to promote healthy urban trees using a subsurface structural cell system that supports the hardscape (eg sidewalk and paving). At trial, McDonald J held DeepRoot’s patents to be valid and infringed, in a straightforward decision which turned on the facts: see here. McDonald J denied DeepRoot’s request to be granted an accounting because she was not satisfied that GreenBlue had in fact made a profit on infringing sales [FC 280]. GreenBlue appealed on liability and DeepRoot cross-appealed McDonald J’s refusal to grant an accounting. The FCA dismissed GreenBlue’s liability appeal on the basis that McDonald J had not made any material error of law and her findings of fact were supported by the evidence.

The FCA held that McDonald J erred in refusing to grant an accounting. The contentious issue was the deductibility of fixed costs. These are costs, such as the cost of lighting the factory or the cost of the financial department, which are necessary to the infringement—you can’t make infringing widgets if the lights are off—but which do not vary with the extent of the infringement and which would have been incurred even if there had been no infringement at all—the lights will be on whether the widgets the factory is making are infringing or non-infringing.

Deductibility of fixed costs is a tricky question. On the one hand, if the fixed costs are the same whether or not the product is infringing, this means that those costs are not caused by the infringement, and so should not be deducted. On the other hand, fixed costs are 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. In Nova v Dow 2020 FCA 141, Stratas JA was persuaded by the latter argument, and held that “[a]ny infringer, regardless of whether it is operating at full capacity, should be able to deduct a proportion of its fixed costs” [162]. This is referred to as the “full costs” approach, in contrast with an “incremental costs” approach in which only costs that vary with the infringement are deductible. See here for a more extended discussion. (The issue of deductibility of fixed costs was not addressed by the SCC on appeal in Nova v Dow 2022 SCC 43.)

The difficulty with a full costs approach is determining what proportion of the fixed costs can be deducted. Nova v Dow itself doesn’t help us answer that question. Fothergill J at trial had allowed deductibility of some fixed costs, but on the basis of an opportunity cost approach endorsed in Dart Industries [1993] HCA 54, according to which the proportion of fixed costs to be deducted turns on the proportion of fixed costs which sustained the foregone opportunity: 2017 FC 350 [161] But Stratas JA explicitly rejected Dart Industries[154], which Fothergill J had relied on, which means that we cannot rely on an opportunity costs approach to tell us what proportion of the fixed costs should be deducted. (While he rejected the reasoning underpinning Fothergill J’s deduction, he nonetheless approved the deduction itself, apparently on the view that Dart Industries is a kind of fixed cost approach, and since a full costs approach is not unsound, it was not an error for Fothergill J to use a full costs approach even though it was based on a wrong principle [163]. As discussed here, the Dart Industries approach is arguably a variation on the incremental cost approach, but that doesn’t really matter at this point.) The point of all this is that while we know the principle applied by Fothergill J in Nova v Dow itself, that does not help us decide what proportion of the fixed costs are to be deducted, because the principle applied in Nova v Dow was wrong.

Turning back to the case at hand, the discussion of this point at trial is brief and cryptic. McDonald J [FC 278] noted the statement in Nova v Dow 2020 FCA 141 that “the ‘full costs’ approach should always be available to an infringer” [145] and then remarked that “[h]aving accepted the financial evidence of GreenBlue, I am not satisfied that GreenBlue has in fact made a profit on sales of RootSpace” [FC 280]. Gleason JA’s decision is not much clearer as to the specifics, but it appears that the main fixed cost at issue was general overhead expenses [72] eg keeping the lights on, and it seems that McDonald J had allowed a deduction of fixed costs proportionate to the percentage of sales generated by the infringing product as a proportion of total sales [92]. (It was uncontested that incremental costs may be deducted [66].)

DeepRoot’s argument, which was accepted by the FCA, was that:

[72] the Federal Court erred in law by failing to conduct the necessary analysis to establish a causal connection between GreenBlue’s claimed overhead and the profits it earned through infringement, thereby allowing GreenBlue to wrongfully shield its profits from disgorgement. DeepRoot adds that there was no evidence to establish what portion of GreenBlue’s general overhead expenses were related to the infringing sales and that it was accordingly an error for the Federal Court to have accepted GreenBlue’s percentage allocation.

So, McDonald J’s error was a failure to establish a causal link between the fixed costs and the infringement.

In Nova v Dow, Stratas JA had implied that it is only the costs that are “caused by the infringement” that are disgorged: [153] (see similarly [157]). The requirement of a causal connection was emphasized even more strongly by Gleason JA in this case. In her review of the law, she stated that “An accounting of profits. . . requires that the defendant disgorge to the plaintiff the amount of profits earned by reason of the infringement” [79] and “With respect to both the remedy of damages and that of disgorgement, proof of a causal connection to the infringement is required” [81]. Similarly, she stated that the full costs approach allows deduction of “fixed overhead costs causally connected to the infringing sales” [85] and “fixed costs that are causally attributable to the infringing product” [88]. She concluded that:

[89] fixed non-incremental overhead costs may be deducted from sales to establish an infringer’s profit, but proof of causation is still required. In other words, the defendant must establish some link between the claimed portion of the overhead and the infringing sales.

This is all well and good. But what is the nature of the causal link? We need to know the causation concept for the parties to know what kind of evidence is relevant.

The most prominent causation concept in law is “but for” causation. On that view, costs are caused by the infringement if they would not have been incurred but for the infringement. In other words, if the causation concept is “but for” causation, then we end up at the incremental cost approach. Since Stratas JA rejected the incremental cost approach in Nova v Dow, “but for” causation can’t be the relevant causation concept. And indeed, Stratas JA also rejected “but for” causation fairly explicitly: see Nova v Dow FCA [148], [151], [153].

The other main causation concept known to law is material contribution. But the material contribution test is disfavoured and is confined to special circumstances, in particular where it is impossible to determine which of a number of negligent acts by multiple actors in fact caused the injury, but it is established that one or more of them did in fact cause it: Clements v Clements 2012 SCC 32 [13], [17], [42]. While the SCC has not ruled out the possibility that material contribution might be applied in other contexts, but no one has ever said this is appropriate in the context of deduction of fixed costs. Moreover, it is difficult to see how it could be applied, since material contribution goes to liability, not apportionment. If the defendant is found liable under a material contribution approach, the defendant is jointly and severally liable for the entire loss: Clements [12]. It is an all or nothing result, which provides no basis for an apportionment.

What other causation concepts might be used? While Stratas JA in Nova v Dow rejected “but for” causation, he did not specify an alternative causation concept. In the absence of a clear causation concept, we might then look to the facts to discover what approach is appropriate. Nova v Dow itself does not provide an answer. Stratas JA only referred in passing to the causation requirement and he did not expressly endorse any causation concept. Nor did he give any example of an appropriate deduction. The closest he came was to say that 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]. This was only by way of a passing example to show that the full costs approach does not imply that the infringer would be able to subsidize its non-infringing products. More importantly, what is the causation concept which supports deduction of a proportionate amount by sales, or profits, or weight, or plant capacity, or whatever it might be? Without a principled causation concept, a deduction based on any of these factors is arbitrary and unprincipled.

As noted, it appears that in this case that McDonald J allowed deduction of fixed costs proportionate to the percentage of sales generated by the infringing product as a proportion of total sales [92]. Gleason JA gave a convincing example to show why this is not always appropriate [94]. But it is unlikely that a deduction proportionate to volume or capacity is always preferable.

In this case, it seems that the failure to call evidence was the key deficiency: see [98]–[101]. It is reasonable that neither volume, nor capacity, nor sales would always be the correct basis for apportionment, but any of them might be, depending on the evidence. But in the absence of a causation concept, what exactly is that evidence trying to prove? How can we know what constitutes evidence of causation, if we don’t know what “causation” means?

Gleason JA gave the example of the trial decision in Nova v Dow, 2017 FC 637, in which Fothergill J allocated fixed costs based on “billed volume” in light of evidence that “the fixed costs per pound were substantially the same for infringing and non-infringing products” [98]. I must admit that I don’t understand what it means to say that fixed costs were the same for infringing and non-infringing products. Fixed costs are costs which do not vary with production, so I don’t see how such costs can be the same for different products, except in a trivial sense that the cost of keeping the lights on is the same no matter what the plant is producing. Perhaps the expert report itself would be more illuminating, but frankly, I doubt it. If an expert has developed a new and appropriate causation concept, it is important as a matter of law that the court tell us that is. In the absence of a specific causation concept which is to be applied to the facts at hand, evidence purporting to tie fixed costs to one product or another is nothing more than a campfire story—a tall tale spun by an expert, but a tall tale nonetheless.

Gleason JA did not specify a causation concept. Instead, she concluded her discussion by saying that “What the foregoing examples demonstrate is that the approach to quantifying overhead costs for purposes of establishing profits earned through infringement is highly fact-dependent” [95]. She then remitted the matter to McDonald J. It is true enough that application of the appropriate causation concept to the facts is highly fact dependent. As the SCC said in Clements v Clements [9], “[t]he ‘but for’ causation test must be applied in a robust common sense fashion.” But the SCC in Clements did specify the causation concept—namely “but for” causation. It is not enough to ask the trial court to look to the facts and apply common sense. Yes, the court must look to the facts — but what are they supposed to be looking for? It is the job of the trial court to apply the law to the facts, and it is the job of the Court of Appeal to tell the trial court what the law is, and the nature of the causation concept is a matter of law.

In the absence of any causation concept, the expert witnesses will tell some kind of story as to why their preferred deduction has some ‘causal’ link to the infringement. McDonald J will have to accept one side or the other, and as long as there is some kind of evidence to point to containing the word “cause”, presumably the FCA will review her decision on a deferential standard and that will be the end of it. But unless and until the FCA tells us what the causation concept is, the deduction of fixed costs in this case and in all future cases will simply be arbitrary and unprincipled.

In my view the appropriate causation concept is “but for” causation. If the FCA wants to abandon “but for” causation in this context, it is incumbent on the Court to tell us what to replace it with. I know the FCA is just following in the footsteps of the SCC in Nova v Dow, in which the Rowe J insisted on the need for a causal link while steadfastly refusing to tell us the causation concept. But the failure of the SCC to define causation is all the more reason that the FCA has to step up.

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